…and heterogeneous cognitive abilities
D’Acunto et al. in this paper argue that heterogeneous cognitive abilities (IQ) among consumers limit the effectiveness of fiscal and monetary policy interventions that target households. In their model people in the bottom half of the population distribution by cognitive abilities, fail to take advantage of policies that aim to stimulate consumption of all financially-unconstrained households, either because they are not aware of the policy changes or do not understand how policy measures affect economic incentives. Cognitive abilities, thus, better explain the limited transmission of economic policies that operate through the household sector than differences in education, income, economic expectations and other demographic characteristics of the population.
They use individual-level information on cognitive abilities for the quasi-universe of Finnish men from the Finnish Defence Forces which administers cognitive-ability tests to Finnish men who register for conscription service. They test their theory by looking at how a “cash-for-clunker” car scrappage scheme – a government provided subsidy to consumers to trade in their existing eligible clunker and purchase an eligible car with the aim to bring forward their durable spending. For that purpose they use administrative data on income, asset holdings, debt levels, interest paid on outstanding debt as well as data on car purchases at the monthly level and the stock of cars owned by Finnish residents at the end of each fiscal year. They find that:
Agents at the top of the distribution by cognitive abilities are twice as likely to take advantage of the scrappage scheme relative to others, in both the raw data and after controlling for income, education, registry-based wealth and financial liquidity, and a broad set of other demographics as well as personal and macroeconomic expectations that might drive agents’ willingness to substitute their durable spending intertemporally.
The outcome of such cognitive differences leads to a re-distribution from low- to high-cognitive-ability agents as the latter behave more in line with the transmission mechanism of macroeconomic policies.
Human Frictions in the Transmission of Economic Policies
Authors: Francesco D’Acunto, Daniel Hoang, Maritta Paloviita, Michael Weber
From: Boston College, Karlsruhe Institute of Technology, Bank of Finland, University of Chicago
…and present-biased time preferences and naive beliefs
In this paper Laibson et al. develop a partial equilibrium heterogeneous agent model where households, whose behavior is influenced by a range of psychological factors, face a complex financial planning problem. In addition to present bias, they assume that households have naive beliefs, as they do not foresee their own bias. They compare the exponential-discounting benchmark to a tractable, and empirically realistic, continuous-time limit of present-biased discounting. Agents differ in their average quantity of credit card debt and the average loan-to-value ratio in the housing market. The authors argue that relative to exponential discounting, present bias amplifies the balance-sheet channels of both fiscal and monetary policy. In particular:
Fiscal policy is powerfully enhanced by present bias, because present bias sharply raises households’ average marginal propensity to consume. […] Present bias also amplifies the overall effect of monetary policy, but slows down the speed of monetary transmission (an offsetting effect). Interest rate cuts incentivize households to conduct cash-out refinances, which serve as targeted liquidity-injections to households with especially high MPCs (because they are near their liquidity constraint). But present bias with naive beliefs also introduces a motivation for households to procrastinate on refinancing their mortgage, which substantially slows down the speed at which this channel operates.
Present Bias Amplifies the Household Balance-Sheet Channels of Macroeconomic Policy
Authors: David Laibson, Peter Maxted, Benjamin Moll
From: Harvard University, Berkeley Haas, London School of Economics
