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Rationalizing multiple consumption-saving puzzles in a unified framework

  • Kevin Huang


  • Frank Caliendo

Empirical evidence suggests that it may cost time, effort, and resources to implement an optimal consumption-saving plan, although the cost may differ across individuals. This paper explores the implications of such friction. We begin by documenting a series of facts on consumption and savings over the life cycle, each of which goes against the prediction of the standard life-cycle model. While the existing studies demonstrate how various permutations of the benchmark model may help resolve one or another of these puzzles, it appears difficult to jointly rationalize even a small subset of these facts within the existing theories. We then incorporate a feature of costly implementation into the benchmark model and show that the addition of this one feature moves in the right direction in jointly resolving all these puzzles. This friction is the sole and common mechanism in our model for rationalizing this series of facts, as we intentionally abstract from the mechanisms explored in the existing literature that are known to help explain one or another of these facts, in order to isolate the role of costly implementation. The implementation costs in the model are small, yet our results show that the mechanism can be important in complementing the existing theories to help account for these consumption and saving facts in a unified framework.

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Article provided by Springer in its journal Frontiers of Economics in China.

Volume (Year): 6 (2011)
Issue (Month): 3 (September)
Pages: 359-388

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Handle: RePEc:spr:frecch:v:6:y:2011:i:3:p:359-388
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