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Bad Luck or Bad Decisions? Macroeconomic Implications of Persistent Heterogeneity in Cognitive Skills and Overconfidence

Author

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  • Oliver Pfäuti
  • Fabian Seyrich
  • Jonathan Zinman

Abstract

Business cycle models often abstract from persistent household heterogeneity, despite its potentially significant implications for macroeconomic fluctuations and policy. We show empirically that the likelihood of being persistently financially constrained decreases with cognitive skills and increases with overconfidence thereon. Guided by this and other micro evidence, we add persistent heterogeneity in cognitive skills and overconfidence to an otherwise standard HANK model. Overconfidence proves to be the key innovation, driving households to spend instead of precautionary save and producing empirically realistic wealth distributions and hand-to-mouth shares and MPCs across the income distribution. We highlight implications for various fiscal policies.

Suggested Citation

  • Oliver Pfäuti & Fabian Seyrich & Jonathan Zinman, 2024. "Bad Luck or Bad Decisions? Macroeconomic Implications of Persistent Heterogeneity in Cognitive Skills and Overconfidence," Discussion Papers of DIW Berlin 2080, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp2080
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    References listed on IDEAS

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    Cited by:

    1. Christa Gibbs & Benedict Guttman-Kenney & Donghoon Lee & Scott Nelson & Wilbert van der Klaauw & Jialan Wang, 2025. "Consumer Credit Reporting Data," Journal of Economic Literature, American Economic Association, vol. 63(2), pages 598-636, June.
    2. Gizem Koşar & Davide Melcangi, 2025. "Subjective Uncertainty and the Marginal Propensity to Consume," Staff Reports 1148, Federal Reserve Bank of New York.
    3. Zaccaria, Niccolò, 2025. "Overconfidence and Information Aggregation," Other publications TiSEM 7ac7f3a2-0a15-4d18-b645-6, Tilburg University, School of Economics and Management.

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    Keywords

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    JEL classification:

    • 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
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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