Temptation and Commitment: Understanding Hand-to-Mouth Behavior
This paper presents a model of consumption behavior that explains the presence of ‘wealthy hand-to-mouth’ consumers using a mechanism that differs from those analyzed previously. We show that a two-asset model with temptation preferences generates a demand for commitment and thus illiquidity, leading to hand-to-mouth behavior even when liquid assets deliver higher returns than illiquid assets. This model fits other features of the data, such as the fact that the Marginal Propensity to Consume declines only slowly with shock size. Moreover, temptation and commitment have important policy implications: we show that housing subsidies and mandatory mortgage amortization increase household savings.
An earlier version of this paper was circulated as Kovacs and Moran (2018) “Temptation, Commitment, and Hand-to-Mouth Consumers”. We are grateful to Taha Choukhmane, Andreas Fagereng, Andrea Ferrero, Greg Kaplan, Mike Keane, Hamish Low, Costas Meghir, Ben Moll, Peter Neary, Cormac O’Dea, Carlo Pizinelli, Akos Valentinyi, Gianluca Violante, and seminar participants at Oxford, Yale, Manchester, Reserve Bank of New Zealand, Statistics Norway, Bank of England, and Institute for Fiscal Studies for helpful comments. We would like to acknowledge the use of the University of Oxford Advanced Research Computing (ARC) facility in carrying out this work (http://dx.doi.org/10.5281/zenodo.22558). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.