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Rationalizing multiple consumption-saving puzzles in a unified framework

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  • Kevin Huang
  • Frank Caliendo

Abstract

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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  • Kevin Huang & Frank Caliendo, 2011. "Rationalizing multiple consumption-saving puzzles in a unified framework," Frontiers of Economics in China, Springer;Higher Education Press, vol. 6(3), pages 359-388, September.
  • Handle: RePEc:spr:frecch:v:6:y:2011:i:3:p:359-388
    DOI: 10.1007/s11459-011-0138-0
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    Cited by:

    1. Frank Caliendo & T. Findley, 2013. "Limited computational ability and social security," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(3), pages 414-433, June.
    2. Michael Boutros, 2022. "Windfall Income Shocks with Finite Planning Horizons," Staff Working Papers 22-40, Bank of Canada.
    3. Arna Olafsson & Michaela Pagel, 2018. "The Retirement-Consumption Puzzle: New Evidence from Personal Finances," NBER Working Papers 24405, National Bureau of Economic Research, Inc.
    4. Choi, Kyoung Jin & Jeon, Junkee & Koo, Hyeng Keun, 2022. "Intertemporal preference with loss aversion: Consumption and risk-attitude," Journal of Economic Theory, Elsevier, vol. 200(C).
    5. Emin Gahramanov & Xueli Tang, 2016. "Impatient in Experiments, but Patient in Simulations: A Challenge to the Heckman-Type Model," The Economic Record, The Economic Society of Australia, vol. 92(297), pages 268-290, June.

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    More about this item

    Keywords

    implementation cost; heterogeneity; consumption; saving; life cycle; C61; D91; E21;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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