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Overpersistence Bias in Individual Income Expectations and its Aggregate Implications

Author

Listed:
  • Schlafmann, Kathrin
  • rozsypal, filip
Abstract
We study the role of household income expectations for consumption decisions. Using micro level data, we first document an systematic, income-related component in household income forecast errors. These systematic errors can be explained by a modest deviation from rational expectations, where agents overestimate the persistence of their income process. We then study the implications of this bias in a quantitative model. Low income households who overestimate the persistence of their income are too pessimistic about their future income. This has two effects. First, these households are unwilling to borrow to smooth their consumption even though their borrowing constraint is not binding, thereby allowing the quantitative model to match the distribution of liquid assets across the income distribution. Second, they have lower marginal propensities to consume than their fully rational counterparts. Disregarding the bias in income expectations thus leads standard models to overpredict the effectiveness of government stimulus payments.

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  • Schlafmann, Kathrin & rozsypal, filip, 2017. "Overpersistence Bias in Individual Income Expectations and its Aggregate Implications," CEPR Discussion Papers 12028, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12028
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    3. Altig, David & Barrero, Jose Maria & Bloom, Nicholas & Davis, Steven J. & Meyer, Brent & Parker, Nicholas, 2022. "Surveying business uncertainty," Journal of Econometrics, Elsevier, vol. 231(1), pages 282-303.
    4. Barrero, Jose Maria, 2022. "The micro and macro of managerial beliefs," Journal of Financial Economics, Elsevier, vol. 143(2), pages 640-667.
    5. Francesco D’Acunto & Daniel Hoang & Maritta Paloviita & Michael Weber, 2023. "IQ, Expectations, and Choice," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 90(5), pages 2292-2325.
    6. Marta Cota, 2023. "Extrapolative Income Expectations and Retirement Savings," CERGE-EI Working Papers wp751, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    7. Massenot, Baptiste & Pettinicchi, Yuri, 2019. "Can households see into the future? Survey evidence from the Netherlands," Journal of Economic Behavior & Organization, Elsevier, vol. 164(C), pages 77-90.
    8. Greg Howard & Carl Liebersohn, 2019. "What Explains U.S. House Prices? Regional Income Divergence," 2019 Meeting Papers 1054, Society for Economic Dynamics.
    9. Richard Foltyn & Jonna Olsson, 2024. "Subjective life expectancies, time preference heterogeneity, and wealth inequality," Quantitative Economics, Econometric Society, vol. 15(3), pages 699-736, July.
    10. Nils Grevenbrock & Max Groneck & Alexander Ludwig & Alexander Zimper, 2021. "Cognition, Optimism, And The Formation Of Age‐Dependent Survival Beliefs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 62(2), pages 887-918, May.
    11. Bassanin, Marzio & Faia, Ester & Patella, Valeria, 2021. "Ambiguity attitudes and the leverage cycle," Journal of International Economics, Elsevier, vol. 129(C).
    12. Jeanne Commault, 2024. "Heterogeneity in MPC Beyond Liquidity Constraints: The Role of Permanent Earnings," Working Papers hal-03870685, HAL.
    13. Francisco Amaral & Martin Dohmen & Sebastian Kohl & Moritz Schularick, 2021. "Superstar Returns," SciencePo Working papers Main hal-03881493, HAL.
    14. Kovacs, Agnes & Rondinelli, Concetta & Trucchi, Serena, 2021. "Permanent versus transitory income shocks over the business cycle," European Economic Review, Elsevier, vol. 139(C).
    15. Grimaud, Alex, 2021. "Precautionary saving and un-anchored expectations," MPRA Paper 110651, University Library of Munich, Germany.
    16. Greg Howard & Jack Liebersohn, 2023. "Regional Divergence and House Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 49, pages 312-350, July.
    17. Sean Hundtofte & Arna Olafsson & Michaela Pagel, 2019. "Credit Smoothing," NBER Working Papers 26354, National Bureau of Economic Research, Inc.
    18. Broer, Tobias, 2020. "Consumption insurance over the business cycle," CEPR Discussion Papers 14579, C.E.P.R. Discussion Papers.
    19. Tao Wang, 2023. "Perceived versus Calibrated Income Risks in Heterogeneous-Agent Consumption Models," Staff Working Papers 23-59, Bank of Canada.
    20. Faia, Ester & Bassanin, Marzio & Patella, Valeria, 2019. "Ambiguity Attitudes, Leverage Cycle and Asset Prices," CEPR Discussion Papers 13875, C.E.P.R. Discussion Papers.
    21. Anmol Bhandari & Jaroslav Borovicka & Paul Ho, 2019. "Survey Data and Subjective Beliefs in Business Cycle Models," Working Paper 19-14, Federal Reserve Bank of Richmond.

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    More about this item

    Keywords

    Household income expectations; Savings; Durable consumption;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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