Principal investigator: Viviane Pires Ribeiro
Paper Title: Self-control and saving for retirement
Authors: David I. Laibson, Andrea Repetto and Jeremy Tobacman
Location of the Intervention: United States
Sample Size: Not specified
Main theme: Finances
Main Variable of Interest: Savings
Type of Intervention: Analysis of defined contribution pension plans with deferred taxes.
Methodology: Hyperbolic model
The gap between intentions and actions is evident in life-cycle economics, and this is the focus of the study conducted by Laibson et al. (1998). According to the authors, some experts have called for a relaxation of penalties for early withdrawals from savings plans, believing that people would invest more if they knew they could withdraw their money at any time. But most Americans seem cautious about these changes. Sixty percent of Americans say it is better to maintain, rather than loosen, legal restrictions on retirement plans to prevent people from using the money for other purposes. Only 36 percent preferred to make withdrawals more accessible so that people can enjoy their savings before retirement.
Evaluation Context
There is a systematic conflict between the short-term and long-term preferences of economic agents. When two alternative rewards are far apart in time, decision-makers generally act with relative patience: for example, it is preferable to take a thirty-minute break from work in 101 days, rather than a fifteen-minute break in one hundred days. But when both rewards are brought forward in time, decision-makers reverse their preferences, becoming more impatient: thus, it is preferable to take a fifteen-minute break now, rather than a thirty-minute break tomorrow. Evidence of such reversals has been found in experiments using a wide range of real rewards, such as money, durable goods, fruit juice, sweets, relief from harmful noise, access to video games, among others. www.estsolar.lt Estsolar saulės elektrinės go parkai
Several studies have used multiple-self frameworks to model this gap between short-term and long-term preferences. The authors highlighted the conflict between the long-term desire to be patient and the short-term desire for instant gratification. This conflict can be captured in a particularly parsimonious manner, allowing discount functions to decrease at a steeper rate in the short term than in the long term.
Intervention Details
Standard economic theories allow consumers to make mistakes, but imply that these mistakes will not be systematic: they will tend not to follow the same direction. On the other hand, evidence indicates that most consumers believe they are saving too little. This systematic and self-recognized error contradicts the standard economic model of the maximizing consumer. The study by Laibson et al. (1998) explores an alternative model, from the psychology literature, that can make sense of the apparent conflicts between attitudes, intentions, and behaviors in the domain of saving.
The hyperbolic model helps analyze the problem of undersaving in the United States. It allows economists to assess the likely magnitude of undersaving and identify the types of financial instruments that will alleviate the problem. For example, the objective of the study conducted by Laibson et al. (1998) is to evaluate tax-deferred defined contribution (DC) pension plans. The authors question whether these instruments increase national savings and consumer welfare, and whether they are more effective in an economy populated by consumers with self-control problems.
Methodology Details
Laibson et al. (1998) develop and evaluate a hyperbolic model for simulating consumer behavior. Simulations are a critical tool for predicting the long-term effects of newly implemented policies and for evaluating the short- and long-term effects of untested policy proposals. The simulation approach has a major flaw that the authors point out upfront: they adopt the standard economic assumption of unlimited sophistication in problem-solving. Consumers in the proposed model perfectly solve a complex feedback problem when making choices about consumption and asset allocation.
The authors chose this approach for two reasons. First, the assumption of perfect rationality is the natural reference point for an economist. This assumption was adopted not because it necessarily adequately describes consumer behavior, but because it represents the starting point for all economic analyses. Second, even if one wants to weaken assumptions about consumer sophistication, it is unclear how to do so in a parsimonious and realistic way. Although economists and psychologists have much evidence that consumers are not perfectly rational, they do not necessarily know which alternative to rationality should be adopted. There are no well-developed bounded rationality models applicable to the life-cycle economics problem.
Results
The study conducted by Laibson et al. (1998) shows that the lifecycle consumption and asset accumulation patterns are consistent with a hyperbolic model. At first glance, the lifecycle choices of hyperbolic and exponential consumers are indistinguishable. However, hyperbolic consumers exhibit some special regularities that allow researchers to distinguish them from their exponential counterparts: they are much more likely to encounter liquidity constraints and exhibit the anomalous effects of precautionary saving. These hyperbolic phenomena are implicit in the generalized Euler equation.
The authors considered another distinction between hyperbolic and exponential behavior. They show that hyperbolic consumers react much more favorably to defined contribution pension plans than equivalent exponential consumers. Benchmark simulations for an exponential economy – with a relative risk aversion coefficient of 1 and an intertemporal replacement measure elasticity of 0,27 – indicate that DC plans with early withdrawal penalties between 10% and 50% increase steady-state net national savings by 61 percent to 102 percent. Conversely, in a hyperbolic economy (with a relative risk aversion coefficient of 1 and an intertemporal replacement measure elasticity of 0,22), these plans increase the steady-state net national savings rate by 81 percent to 134%. These results are sensitive to calibration of the relative risk aversion coefficient. Higher values of the relative risk aversion coefficient significantly reduce the effects of direct investment plans on exponential and hyperbolic economies.
Lessons in Public Policy
Research on animal and human behavior has led psychologists to conclude that short-term discount rates are much higher than long-term rates. Such preferences are formally modeled with discount functions that are generalized hyperbolas. This discount structure creates a conflict between current preferences and those that will be held in the future, implying that preferences are dynamically inconsistent.
Therefore, hyperbolic consumers will report a gap between what they think they should save and what they actually save. Normative savings rates will be above actual savings rates, as short-term preferences for instant gratification will undermine the consumer's effort to implement optimal long-term plans. However, the hyperbolic consumer is not doomed to be a "loser." Commitment devices, such as pensions and illiquid assets, can help the hyperbolic consumer commit, thus increasing their well-being. The availability of illiquid assets is therefore a critical determinant of national savings rates as well as consumer well-being. But too much illiquidity can be problematic. Consumers face substantial risk of uninsurable labor income and need liquid assets to smooth their consumption. Hyperbolic agents seek financial instruments that strike the right balance between commitment and flexibility.
The gap between intentions and actions is evident in life-cycle economics, and this was the focus of the study conducted by Laibson et al. (1998). The authors show that the hyperbolic assumption has important implications for positive and normative conclusions about savings behavior. The analysis complements the extensive and active empirical literature on the effectiveness of tax-deferred savings instruments, such as individual retirement accounts and 401(k) plans – the 401k being a retirement plan that allows a client to use part of their salary for long-term investments. Thus, the authors identified that conclusions about the effectiveness of these instruments critically depend on poorly identified characteristics of consumer preferences.
References
LAIBSON, David I. et al. Self-control and saving for retirement. Brookings papers on economic activity, v. 1998, no. 1, p. 91-196, 1998.
