Intertemporal Tradeoffs Research Articles

Measuring Time Preferences.

We review research that measures time preferences-i.e., preferences over intertemporal tradeoffs. We distinguish between studies using financial flows, which we call "money earlier or later" (MEL) decisions and studies that use time-dated consumption/effort. Under different structural models, we show how to translate what MEL experiments directly measure (required rates of return for financial flows) into a discount function over utils. We summarize empirical regularities found in MEL studies and the predictive power of those studies. We explain why MEL choices are driven in part by some factors that are distinct from underlying time preferences.

Financial Vulnerabilities, Macroeconomic Dynamics, and Monetary Policy

We define a measure to be a financial vulnerability if, in a VAR framework that allows for nonlinearities, an impulse to the measure leads to an economic contraction. We evaluate alternative macrofinancial imbalances as vulnerabilities: nonfinancial sector credit, risk appetite of financial market participants, and the leverage and short-term funding of financial firms. We find that nonfinancial credit is a vulnerability: impulses to the credit-to-GDP gap when it is high leads to a recession. Risk appetite leads to an economic expansion in the near-term, but also higher credit and a recession in later years, suggesting an intertemporal tradeoff. Monetary policy is generally ineffective at slowing the economy once the credit-to-GDP gap is high, suggesting important benefits from avoiding excessive credit growth. Financial sector leverage and short-term funding do not lead directly to contractions and thus are not vulnerabilities by our definition.

FISCAL POLICY AND THE REAL EXCHANGE RATE

This paper examines the mechanisms through which government spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral mobility costs for private capital, we show that public investment generates (i) a nonmonotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-offs and (ii) a crowding-in of private consumption, consistent with stylized facts. The effects of public consumption, however, are in sharp contrast to those of public investment. The effect of government spending on the real exchange rate depends critically on (i) the sectoral composition of public spending, (ii) the underlying financing policy, (iii) the sectoral intensity of private capital in production, (iv) the relative sectoral productivity of public infrastructure, (v) the elasticity of substitution in production, and (vi) intersectoral mobility costs for capital. In deriving these results, we identify conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities. Our results underscore the importance of decoupling the effects of government investment from those of government consumption in understanding the relationship between fiscal policy and the real exchange rate.

Dietary quality as a non-medical health input: a theoretical approach to analyse the demand for dietary quality

The aim of this inquiry is to provide a comprehensive theoretical framework, which describes the demand for dietary quality. In our dietary health investment model, we consider the health investment character of dietary choices as well as the intertemporal health-taste trade-off. Additionally, a simulation model is presented to illustrate the model's empirical application as well as its capability to replicate the patterns of dietary quality found in other empirical studies. As a result, our model setting can aid food and nutrition policy through an increased understanding of the responsible causal pathways behind the increasing prevalence of diet-related chronic diseases.

Time delay, complexity and support for taxation

People often experience the benefits of taxation over time. We design an intertemporal market experiment with negative externalities to examine how delaying the benefits of taxation affects support for taxes. We find that when negative externalities occur immediately, people learn to adopt Pigouvian taxes, which are aimed at reducing negative externalities and restoring market efficiency. By contrast, when negative externalities are delayed, people are less receptive to taxation. This effect persists over time. Our data reveal that the strong negative delay effect can be explained in large part by narrow bracketing and the increased perceived complexity of the environment, rather than by time discounting per-se. We argue and demonstrate that increasing the transparency of intertemporal tradeoffs can effectively promote support for taxation.

Earnings Pressure and Long-Term Corporate Governance: Can Long-Term-Oriented Investors and Managers Reduce the Quarterly Earnings Obsession?

Recent research has shown that managers in publicly traded companies facing earnings pressure—the pressure to meet or beat securities analysts’ earnings forecasts—may make business decisions to improve short-term earnings. Analysts’ forward-looking performance forecasts can serve as powerful motivation for managers, but may also encourage them to undertake short-term actions detrimental to future competitiveness and performance. To identify whether managerial reactions to earnings pressure suggest evidence of intertemporal trade-offs, we explored how companies respond to earnings pressure under different conditions of corporate governance that shape the temporal orientations of managers. Using data on competitive decisions made by U.S. airlines under quarterly earnings pressure, we examined the effect of earnings pressure on competitive behavior under different ownership structures (ownership by long-term dedicated investors versus transient investors) and CEO incentives (unvested incentives that are restricted or unexercisable in the short term, versus vested incentives). The results suggest that companies with more long-term-oriented investors and long-term-aligned CEOs with unvested incentives are less likely to soften competitive behavior in response to earnings pressure, relative to companies with transient investors and CEOs with vested, immediately exercisable stock-based incentives. Using a difference-in-differences (DiD) specification for stronger identification, we also found that firms respond to their rivals’ earnings pressure shocks by increasing capacity and prices, particularly when those rivals do not have long-term-oriented investors and CEO incentives. The evidence is more aligned with the view that the pursuit of short-term earnings as a result of earnings pressure may be detrimental to long-term competitiveness.

Inequality and Sovereign Default under Democracy

Do differences in the inequality of income affect the likelihood that democratic governments decide not to honor their foreign debt contracts? I argue that sovereign default involves an intertemporal tradeoff between an immediate consumption boost and a future tax increase. Since a poorer voter internalizes less of the future cost of default, as the median is poorer, the majority’s demand for default increases. Therefore, greater income inequality implies a higher default risk. I then present a signaling game that models strategic selection that a sovereign must go through to get to the default decision node. I show that sovereign default is most likely to actually occur when the level of income inequality is intermediate. The intuition is that sovereign default occurs when risky sovereigns successfully induce creditors to provide a loan, but the most risky ones are among those least able to do so. Empirical findings support the claim.

The effect of saving on risk attitudes and intertemporal choices

We investigate whether access to savings accounts affects choices individuals make about financial risk and intertemporal tradeoffs. We exploit a field experiment that randomized access to savings accounts among a largely unbanked population of Nepalese villagers. One year after the accounts were introduced, we administered lottery-choice and intertemporal-choice tasks to the treatment and control groups. We find that the treatment is more willing to take risks in the lottery-choice task and is more responsive to changes in experimental interest rates in the intertemporal-choice task. The results on time discounting are less conclusive, but suggest that the treatment group is more willing to delay receiving money. These results suggest that access to formal savings devices has a positive feedback loop for poor families by increasing their willingness to take risks and to delay gratification.

Advertising and Quality-Dependent Word-of-Mouth in a Contagion Sales Model

In the literature on marketing models, the assumption of mixed word-of-mouth has been limited to the Bass diffusion model. Yet explicit leveraging of the originating factors of such assumption is lacking. Apart from that example, mixed word-of-mouth has been disregarded in contagion sales models. This paper bridges the gap by suggesting a sales model, where both positive and negative word-of-mouth affect the attraction rate of new customers, along with advertising. The difference between positive and negative word-of-mouth is based on the distinction between satisfied and dissatisfied current customers, which is supposed to depend on conformance quality. A primary issue in this paper is to determine how a firm should determine the optimal intertemporal trade-off between investing in advertising-dependent word-of-mouth and quality-dependent word-of-mouth. To address this issue, a contagion sales model is suggested where mixed autonomous word-of-mouth alone can lead to either commercial success or failure of a given brand.

Supplemental Material for Cumulative Weighing of Time in Intertemporal Tradeoffs

Supplemental Material for Cumulative Weighing of Time in Intertemporal Tradeoffs

Fiscal policy in debt constrained economies

We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk and limited commitment to tax plans. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the economy is subject to sovereign debt constraints and the domestic households are impatient relative to the international interest rate. The front loading of tax distortions allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism, providing a link with the closed-economy literature that has explored disagreement between the government and its citizens regarding inter-temporal tradeoffs.

Discounting over subjective time: Subjective time perception helps explain multiple discounted utility anomalies

Consumers often face choices involving intertemporal tradeoffs. Existing research suggests that, in general, decision makers do not obey discounted utility theory because their discount rates are context dependent. Recent literature incorporates decision makers' subjective perception of time into the classic discounted utility model and finds relatively constant discount rates over subjective time. In the current study, we investigated the magnitude effect with subjective time, provided a holistic view via a more comprehensive experiment including multiple anomalies, and found that subjective time perception was able to explain most of the anomalies simultaneously in a single scenario.

Optimal control of a terror queue

The task of covert intelligence agents is to detect and interdict terror plots. Kaplan (2010) treats terror plots as customers and intelligence agents as servers in a queuing model. We extend Kaplan’s insight to a dynamic model that analyzes the inter-temporal trade-off between damage caused by terror attacks and prevention costs to address the question of how many agents to optimally assign to such counter-terror measures. We compare scenarios which differ with respect to the extent of the initial terror threat and study the qualitative robustness of the optimal solution. We show that in general, the optimal number of agents is not simply proportional to the number of undetected plots. We also show that while it is sensible to deploy many agents when terrorists are moderately efficient in their ability to mount attacks, relatively few agents should be deployed if terrorists are inefficient (giving agents many opportunities for detection), or if terrorists are highly efficient (in which case agents become relatively ineffective). Furthermore, we analyze the implications of a policy that constraints the number of successful terror attacks to never increase. We find that the inclusion of a constraint preventing one of the state variables to grow leads to a continuum of steady states, some which are much more costly to society than the more forward-looking optimal policy that temporarily allows the number of terror attacks to increase.

Exchange Rate Predictability and the Skewness of Bid-Ask Spreads

I find, regardless of the exchange rate series utilized, that the incorporation of conditional (predicted) skewness as an exogenous variable in ARCH models of the exchange rate process induces significant decreases in the price of exchange rate volatility risk alongside decreases in the risk that dealers will incur losses in transactions with informed traders. In out-of-sample tests, I find ARCH models that incorporate the conditional skewness factor (augmented ARCH models) have better forecast power in relation to ARCH models that exclude the conditional skewness factor (non-augmented ARCH models) only within a low risk foreign exchange market. In aggregate, empirical findings provide evidence of an inverse relation between market risk and market efficiency within the cross-section of foreign exchange markets. This inverse relation is not predicted by theories of market efficiency or theories of intertemporal risk-return trade-offs, but can be induced by market frictions within foreign exchange markets.

Temporal Stability of Time Preferences

Abstract The preferences assumed to govern intertemporal trade-offs are generally considered to be stable economic primitives, though evidence on this stability is notably lacking. We present evidence from a large field study conducted over two years, with around 1,400 individuals using incentivized intertemporal choice experiments. Aggregate choice profiles and corresponding estimates of discount parameters are unchanged over the two years and individual correlations through time are high by existing standards. However, some individuals show signs of instability. By linking experimental measures to administrative tax records, we showthat identified instability is uncorrelated with both levels and changes in sociodemographic variables.

Stochastically Optimized, Carbon-Reducing Dispatch of Storage, Generation, and Loads

We present a new formulation of a hybrid stochastic-robust optimization and use it to calculate a look-ahead, security-constrained optimal power flow. It is designed to reduce carbon dioxide ( <formula formulatype="inline" xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex Notation="TeX">${\rm CO}_{2}$</tex></formula> ) emissions by efficiently accommodating renewable energy sources and by realistically evaluating system changes that could reduce emissions. It takes into account ramping costs, <formula formulatype="inline" xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex Notation="TeX">${\rm CO}_{2}$</tex></formula> damages, demand functions, reserve needs, contingencies, and the temporally linked probability distributions of stochastic variables such as wind generation. The inter-temporal trade-offs and transversality of energy storage systems are a focus of our formulation. We use it as part of a new method to comprehensively estimate the operational net benefits of system changes. Aside from the optimization formulation, our method has four other innovations. First, it statistically estimates the cost and <formula formulatype="inline" xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex Notation="TeX">${\rm CO}_{2}$</tex></formula> impacts of each generator's electricity output and ramping decisions. Second, it produces a comprehensive measure of net operating benefit, and disaggregates that into the effects on consumers, producers, system operators, government, and <formula formulatype="inline" xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex Notation="TeX">${\rm CO}_{2}$</tex></formula> damage. Third and fourth, our method includes creating a novel, modified Ward reduction of the grid and a thorough generator dataset from publicly available information sources. We then apply this method to estimating the impacts of wind power, energy storage, and operational policies.

A Dynamic Structural Model for Heterogeneous Mobile Data Consumption and Promotion Design

This paper studies how individual users who subscribe to limited monthly mobile data plans dynamically consume data on a daily basis. Employing a unique data set on users' daily mobile data usage from a large mobile carrier, we develop a dynamic structural model in which an individual user maximizes her data usage utility by considering the intertemporal trade-off between current and future consumption. The model contains individual-specific utility parameters to fully capture the heterogeneity in consumption behavior across mobile data users. Theoretical properties derived from the model enable us to discover distinct usage patterns for both forward-looking and myopic users. We then empirically test for forward-looking consumption patterns in order to control for possible consumer myopia. For each of the users with forward-looking consumption patterns, we estimate her structural utility parameters such as price sensitivity. We find simulated individual consumption based on our model estimates can correctly capture the dynamic trends observed in the actual individual consumption. We also conduct counterfactual simulations to investigate how month-end promotions and discounts can stimulate individual mobile data consumption and increase carrier profit.

A Dynamic Structural Model for Heterogenous Mobile Data Consumption and Promotion Design

This paper studies how individual users who subscribe to limited monthly mobile data plans dynamically consume data on a daily basis. Employing a unique data set on users' daily mobile data usage from a large mobile carrier, we develop a dynamic structural model in which an individual user maximizes her data usage utility by considering the intertemporal trade-off between current and future consumption. The model contains individual-speci fic utility parameters to fully capture the heterogeneity in consumption behavior across mobile data users. Theoretical properties derived from the model enable us to discover distinct usage patterns for both forward looking and myopic users. We then empirically test for forward-looking consumption patterns in order to control for possible consumer myopia. For each of the users with forward-looking consumption patterns, we estimate her structural utility parameters such as price sensitivity. We find simulated individual consumption based on our model estimates can correctly capture the dynamic trends observed in the actual individual consumption. We also conduct counterfactual simulations to investigate how month-end promotions and discounts can stimulate individual mobile data consumption and increase carrier pro fit.

A Biological Theory of Social Discounting

We consider a growth model in which intergenerational transfers are made via stocks of private and public capital. Private capital is the outcome of individuals' private savings while decisions regarding public capital are made collectively. We hypothesize that private saving choices evolve through individual selection while public saving decisions are the result of group selection. The main result of the paper is that the equilibrium rate of return to private capital is at least 2–3 percent more than the rate of return to public capital. In other words, social choices involving intertemporal trade-offs exhibit much more patience than individual choices do. (JEL D11, D71, D91, H43)

Monetary Policy, Financial Conditions, and Financial Stability

We review a growing literature that incorporates endogenous risk premiums and risk-taking in the conduct of monetary policy. Accommodative policy can create an intertemporal tradeoff between improving current financial conditions at a cost of increasing future financial vulnerabilities. In the United States, structural and cyclical macroprudential tools to reduce vulnerabilities at banks are being implemented, but may not be sufficient because activities can migrate and there are limited tools for non-bank intermediaries or for borrowers. While monetary policy itself can influence vulnerabilities, its efficacy as a tool will depend on the costs of tighter policy on activity and inflation. We highlight how adding a risk-taking channel to traditional transmission channels could significantly alter a cost-benefit calculation for using monetary policy, and that considering risks to financial stability—as downside risks to employment—is consistent with the dual mandate.