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Rodolfo Rigato (Harvard) "Precautionary Savings and Stabilization Policy in a Present-Biased Economy"
Abstract: Standard heterogeneous-agent (HA) models, as well as their predictions for balance sheet decisions and marginal propensities to consume (MPCs), are premised on the notion that households accumulate precautionary savings due to income risk. But the predicted responses to changes in income risk in these models are an order of magnitude greater than that observed in the data. We measure the precautionary savings channel by studying variation in unemployment insurance (UI) schedules across U.S. states as well as over time. In the data, a 10 p.p. reduction in UI replacement rates is associated with a 1.4% increase in liquid asset holdings. In contrast, the standard HA model generates a 38.1% increase. We show that introducing present bias into an otherwise standard HA model substantially narrows the predicted gap, generating an increase of 1.0%. The model is still able to generate high and dispersed MPCs, partly due to present bias. As an application, we study the stabilization properties of UI and transfer programs to low-income households. We find that in standard HA models transfer programs stabilize aggregate consumption largely through smoothing precautionary savings. When transfers are more generous, households do not need to reduce their consumption to self-insure against higher unemployment risk during recessions. These transfers are therefore less effective stabilization tools when precautionary behavior is dampened by present bias.