Beyond Bad Luck: Macroeconomic Implications of Persistent Heterogeneity In Optimism

Household savings behavior and financial situations have important implications for macroeconomic fluctuations and policy. They are empirically persistent within households and heterogeneous across them. Yet standard modeling practice assumes ex-ante identical households and accounts for heterogeneity only in shock realizations. We consider persistent heterogeneity in a key aspect of consumer decision making—(biased) beliefs about one’s own future financial situation—and show that it strongly conditionally correlates with actual financial decisions and conditions. We use novel microdata to quantitatively discipline ex-ante optimism heterogeneity in an otherwise standard HANK model. Optimistic bias drives households to spend instead of accumulating buffer stock saving and thereby produces more empirically realistic HtM, wealth, and MPC distributions, with optimistic households exhibiting higher MPCs than their rational counterparts even away from the borrowing constraint. Accounting for optimism makes targeted transfers less stimulative and incentivizing self-insurance less effective, but also implies that public insurance is less distortionary.