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Overpersistence Bias in Individual Income Expectations and its Aggregate Implications

Filip Rozsypal and Kathrin Schlafmann

No 12028, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: durable consumption; household income expectations; Savings (search for similar items in EconPapers)
JEL-codes: D14 D84 D91 E21 G02 H31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2017-05
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