MACRO: Quick-Fixing: Near-Rationality in Consumption and Savings Behavior; Dr Joel Flynn (Yale University)

Abstract:

When optimizing consumption-savings decisions is costly, people may instead rely on quick-fixes, simple policy functions that avoid these costs. We introduce a model of quick-fixing. To study it empirically, we field a novel survey that measures households’ consumption policy functions in response to income shocks. Almost 70% of households follow one of four simple quick-fixes that fully consume or fully save out of small shocks, but they abruptly adjust their behavior for large shocks. This behavior accounts for almost half of the cross-sectional variance in marginal propensities to consume, but is poorly predicted by other demographic and economic information. In an incomplete-markets model calibrated to match our evidence, we f ind that quick-fixing is near-rational: the average opportunity cost of quick-fixing is only $17 per quarter. Yet, this small, empirically realistic deviation from the rational model significantly alters aggregate consumption responses to income shocks of varying sizes.

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