Behavioral Savings: Heterogeneous Household Beliefs and Aggregate Nonlinearities.

Abstract

Well documented empirical evidence points to the existence of strong heterogeneity regarding households' savings behavior over the life cycle: individuals endowed with identical inherited wealth, and with similar prospective income earnings and life expectancy, often select antithetical strategies when formulating their consumption-savings intertemporal plans. Underlying this evidence resides the fact that psychology matters, i.e., that economic agents are frequently influenced by their intrinsic beliefs (commanded by genetics and education) and by social and cultural motivations, thus deviating from strict rationality and strict optimal behavior. In this paper, a model of behavioral savings is proposed. In the model, three psychological profiles potentially coexist: individuals can be aligned with the rationality benchmark or, alternatively, they may depart from it by holding optimistic or pessimistic beliefs about future earnings. Each generation of households assumes one of the profiles (rational - optimistic - pessimistic), and new generations form their beliefs by making a constrained assessment of the utility levels attained by the existing generations (namely, they will mimic the behavior of generations which they perceive as being role models). The analysis characterizes the life-cycle implications of assuming each one of the belief profiles and proposes an explanation for aggregate fluctuations in savings and consumption based on the cyclical renewal of beliefs across the mentioned states.