Interacting mechanisms of time inconsistency

Abstract

We interact two prominent behavioral mechanisms of time inconsistency that have been used to study inadequate saving: hyperbolic discounting and short-term planning. Hyperbolic discounting is a conventional way to model impulsive decision making, and short planning horizons have been used to represent myopia. One might expect that interacting both mechanisms within the same model would compound the inadequacy of saving. However, our key finding takes the form of a paradox: hyperbolic discounting does not affect consumption and saving allocations if the planning horizon is short and fixed, although it will affect allocations if the planning horizon is equal to the remaining life span. We demonstrate analytically that this finding is robust to the shape of the disposable income path, to the coarseness of the time grid, and to alternative forms of the period utility function.