Macroeconomic implications of dynamically inconsistent preferences |
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Institution: | 1. Department of Economics, Korea University, Seoul, Republic of Korea;2. Department of Business Administration, Hosei University, Japan;3. Department of Economics, Sungkyunkwan University, Seoul, Republic of Korea;1. Department of Economics, University of Notre Dame, United States of America;2. Department of Econometrics and Operations Research, Tilburg University, The Netherlands;3. Department of Economics, University of California Berkeley, United States of America;1. Faculty of Political Science and Economics, Waseda University, 1-6-1 Nishiwaseda, Shinjuku-ku, Tokyo, 169-8050, Japan;2. Research Institute for Economics and Business Administration, Kobe University, 2-1 Rokkodai-cho, Nada-ku, Kobe, 657-8501, Japan |
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Abstract: | Despite the widespread use of models of intertemporal choices in economics, previous studies have assumed that intertemporal preferences are dynamically consistent. This paper provides a fresh perspective on propagation mechanisms of a typical macroeconomic shock in a model with dynamically inconsistent preferences. To this end, I develop a prototypical neoclassical model that features dynamically inconsistent preferences to explore dynamic responses of key macro-aggregates, discounted cumulative effects and some characteristics of aggregate fluctuations in response to a technology shock. The main findings reveal that (a) consumption and investment in the proposed model show a larger increase than those in a standard neoclassical model; (b) unlike the standard model, the proposed model yields a short-run decline in labor, which is corroborated by previous studies; (c) all of these dynamic responses in the proposed model deliver smaller cumulative output effects; (d) the proposed model does a reasonably good job of matching key characteristics of aggregate fluctuations with the counterparts observed in the postwar U.S. data. The present-bias and sophistication effects are the linchpin of these main results. Various analyses on a set of different parameter values are also discussed. |
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Keywords: | Business cycles Technology shock Dynamically inconsistent preferences Sophistication effect Present-bias effect E20 E32 E70 |
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