Do What We Did Last Year but Don’t Stray Too Far from the Pack, the Role of Behavioral Heuristics in Explaining Municipal Reserve Balances

Abstract

In this paper we leverage a national panel of US municipalities to show that a pair of heuristics identified from the behavioral economics literature, anchoring and the bandwagon effect, help to explain the number of years of expenses municipalities hold in reserve. We build our empirical case using two innovative techniques, a two-stage regression specifically designed to test for anchoring, and a measure of the spatial autocorrelation of reserves. The results strongly suggest that, when it comes to deciding on how much to save, cities target the levels of savings they held in the past, adjusted for the savings levels of their neighbors.