INDIVIDUAL LEARNING ABOUT CONSUMPTION

Abstract

The standard approach to modeling consumption/saving problems is to assume that the decisionmaker is solving a dynamic stochastic optimization problem. However, under realistic descriptions of utility and uncertainty, the optimal consumption/saving decision is so difficult that only recently have economists managed to find solutions, using numerical methods that require previously infeasible amounts of computation. Yet, empirical evidence suggests that household behavior conforms fairly well with the prescriptions of the optimal solution, raising the question of how average households can solve problems that economists, until recently, could not. This paper examines whether consumers might be able to find a reasonably good rule-of-thumb approximation to optimal behavior by trial-and-error methods, as Milton Friedman proposed long ago. We find that such individual learning methods can reliably identify reasonably good rules of thumb only if the consumer is able to spend absurdly large amounts of time searching for a good rule.