Present Bias, Cognitive Bias, and Illiquid Savings

Nobuyuki Oda

No e216, Working Papers from Tokyo Center for Economic Research

Abstract: This paper analyzes consumption and savings of households, who may engage in myopic excess consumption due to present bias, but can also allocate funds into illiquid savings to self-control their consumption. In particular, I focus on situations where households have cognitive biases that lead them to be overconfident so that their present bias can be mitigated in the future, thus leading to inadequate self-control. To contend with this, the government can set a penalty rate for early withdrawals of semi-illiquid savings. The government can also set a subsidy rate for semi-illiquid and fully illiquid savings. These two policy variables are set socially optimally from a paternalistic perspective. In addition, I address cases where households are subject to mental accounting in their consumption with early withdrawals. The analysis will be conducted numerically by constructing a three-period model consisting of households with heterogeneous cognitive biases. Based on the model, I will examine the characteristics of household consumption and savings in different settings, their impact on welfare, the function of illiquid savings, and optimal policy.

Pages: 70 pages
Date: 2025-07
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