Working Paper: NBER ID: w2730
Authors: John H. Cochrane
Abstract: This paper presents calculations of the utility cost to consumers of following alternative decision rules in the environments specified by tests of the intertemporal allocation of consumption on aggregate data. The alternatives include excess and inadequate sensitivity to income and interest rate changes and ignoring information. The calculations find that the costs of large deviations from the optimal decision rule--consumption equal to current income, for example--are on the order of l cent to $1 per quarter. They are interpreted to suggest that the theory does not make predictions that are robust to small inaccuracies of modeling, including small costs of transactions and information, and that those small costs can account for rejections of the theory as it is applied to aggregate US data.
Keywords: Intertemporal Consumption; Utility Costs; Near-Rational Behavior; Permanent Income Hypothesis
JEL Codes: D91; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deviations from the optimal decision rule (D91) | utility losses (L97) |
| first-order mistakes (C20) | second-order utility losses (D11) |
| modeling inaccuracies (C50) | statistical rejections of the intertemporal allocation theory (D15) |