Dynamically Inconsistent Preferences and Money Demand (repeat)

Emanuele Millemaci and Robert Waldmann

This paper focuses on two main issues. First, we find that, on average, households’ discount rates decline. This implies dynamically inconsistent preferences. Second, we calculate an indicator of the degree of dynamic inconsistency that may help us to understand how households overcome their self-control problems. We use a micro data set containing households’ reports on the compensation for receiving hypothetical rewards with delays. We find that individuals with more severely dynamically inconsistent preferences on average hold a statistically significantly lower share of their total wealth in checking accounts. A possible interpretation is that subjects use pre-commitment strategies to limit their temptation to consume immediately.

Please download a pdf of the whole paper

old longer abstract after the jump

OK so there is this wonderful underused dataset from CentER via Luigi Giamboni (warning pdf).

It includes a question on what return people would demand in order to wait 3 months for cash and in order to wait 12 months (no cash really changed hands so it is just a survey not an experiment). One can calculate an annual required interest rate from the answer two the wait three months question. Very often this was much higher than the required annual rate. This means that respondents had dynamically inconsistent preferences. That means (in English) that, given their stated preferences, they would like defend the interests of their 12 months later selves by preventing their 9 months later selves from spending as much as said 9 months later selves would like to spend. If one has dynamically inconsistent preferences one would like to tie one’s future hands.

A sophisticated agent who knows that he or she has dynamically inconsistent preference will find ways to restrict his or her future choices. For example, people with weight problems go to fat farms, People pay for residential drug treatment, drug addled (but not completely addled) celebrities hire dissenablers to prevent them from using drugs etc etc.

If one is worried about future consumption one’s desire for liquidity may actually be negative for some levels of liquidity. I might want to tie my money up in a non liquid asset, say a house, because otherwise I won’t be able to keep myself from spending it. Cash and the balances of checking accounts are very liquid and people with spending problems may rationally choose to hold an unusually small fraction of their wealth as checking account balances.

Why lo and behold the computer says this is true. The coefficient of a household money demand equation on the dynamic inconsistency index is negative and statistically insignificant.

Who ever would have thunk ? Well I would have for 24 years by now, but I never found the data to test the hypothesis.