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Po 19.12.2016

Filip Rozsypal, Ph.D. (LSE) “Overpersistence Bias in Individual Income Expectations and Its Aggregate Implications”

Filip Rozsypal, Ph.D.

London School of Economics, United Kingdom

Authors: Filip Rozsypal and Kathrin Schlafmann

Abstract: We study the role of household income expectations for consumption decisions. Using micro level data, we first document an income-related systematic component in household income forecast errors. We show that 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 over- persistence 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, they 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. This implies that standard models of household consumption overpredict the effectiveness of government stimulus payments if they do not take deviations from rational income expectations into account.

JEL codes: D14, D84, D91, E21, G02, H31

KEYWORDS: household income expectations, savings, durable consumption

Full Text:  “Overpersistence Bias in Individual Income Expectations and Its Aggregate Implications”