Good policies for bad governments: behavioral political economy

Politicians and policymakers are prone to the same biases as private citizens. Even if politicians are rational, little suggests that they have altruistic interests. Such concerns lead us to be wary of proposals that rely on benign governments to implement interventionist policies that "protect us from ourselves." The authors recommend paternalism that recognizes both the promise and threat of activist government. They support interventions that channel behavior without taking away consumers' ability to choose for themselves. Such "benign paternalism" can lead to very dramatic behavioral changes. But benign paternalism does not give government true authority to control our lives and does not give private agents an incentive to reject such authority through black markets and other corrosive violations of the rule of law. The authors discuss five examples of policy interventions that will generate significant welfare gains without reducing consumer liberties. They believe that all policy proposals should be viewed with healthy skepticism. No doctor would prescribe a drug that only worked in theory. Likewise, economic policies should be tested with small-scale field experiments before they are adopted.Macroeconomics ; Economics ; Economic policy

Economic Implications of Extraordinary Movements in Stock Prices

macroeconomics, stock market

Self-Control and Saving for Retirement

macroeconomics, Self-Control, Saving, Retirement

Hyperbolic Discount Functions, Undersaving, and Savings Policy

Studies of animal and human behavior suggest that discount functions are approximately hyperbolic (Ainslie, 1992). I analyze an economy with complete markets which is populated by hyperbolic consumers. I identify two ways in which this economy can be distinguished from an exponential economy. First, hyperbolic discounting predicts the empirical regularity that the elasticity of intertemporal substitution is less than the inverse of the coefficient of relative risk aversion. Second, hyperbolic discounting explains many features of the policy debate about undersaving. The calibrated hyperbolic economy matches Bernheim's (1994) survey data on self-reported undersaving, and predicts pro-savings government interventions like capital-income subsidies and penalties for early withdrawal from retirement accounts. Hyperbolic consumers are willing to sacrifice 9/10 of a year's worth of income to induce the government to implement optimal revenue-neutral saving incentives.

The Seven Properties of Good Models

Economic

Instantaneous Gratification

Extending Barro (1999) and Luttmer & Mariotti (2003), we introduce a new model of time preferences: the instantaneous-gratification model. This model applies tractably to a much wider range of settings than existing models. It applies to both complete- and incomplete-market settings and it works with generic utility functions. It works in settings with linear policy rules and in settings in which equilibrium cannot be supported by linear rules. The instantaneous-gratification model also generates a unique equilibrium, even in infinite-horizon applications, thereby resolving the multiplicity problem hitherto associated with dynamically inconsistent models. Finally, it simultaneously features a single welfare criterion and a behavioral tendency towards overconsumptionEconomic

Capital Flows, Consumption Booms and Asset Bubbles: A Behavioural Alternative to the Savings Glut Hypothesis

Bernanke (2005) hypothesized that a “global savings glut” was causing large trade imbalances. However, we show that the global savings rates did not show a robust upward trend during the relevant period. Moreover, if there had been a global savings glut there should have been a large investment boom in the countries that imported capital. Instead, those countries experienced consumption booms. National asset bubbles explain the international imbalances. The bubbles raised consumption, resulting in large trade deficits. In a sample of 18 OECD countries plus China, movements in home prices alone explain half of the variation in trade deficits.Economic

Natural Expectations and Macroeconomic Fluctuations

Economic

A Cue-Theory of Consumption

Psychological experiments demonstrate that repeated pairings of a cue and a consumption good eventually create cue-based complementarities: the presence of the cue raises the marginal utility derived from consumption. In this paper, such dynamic preferences are embedded in a rational choice model. Behavior that arises from this model is characterized by endogenous cue sensitivities, costly cue-management, commitment, and cue-based spikes in impatience. The model is used to understand addictive/habit-forming behaviors and marketing. The model explains why preferences change rapidly from moment to moment, why temptations should sometimes be avoided, and how firms package and position goods.Economic

Natural Expectations, Macroeconomic Dynamics, and Asset Pricing

Economic