Reference-Dependent Consumption Plans

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Abstract:

We develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption. Because changes in wealth are news about future consumption, preferences over money are reference-dependent. If news resonates more when about imminent consumption than when about future consumption, a decision maker might (to generate pleasant surprises) overconsume early relative to the optimal committed plan, increase immediate consumption following surprise wealth increases, and delay decreasing consumption following surprise losses. Since higher wealth mitigates the effect of bad news, people exhibit an unambiguous first-order precautionary-savings motive.

Document Type: Research Article

DOI: http://dx.doi.org/10.1257/aer.99.3.909

Publication date: June 1, 2009

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