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Hyperbolic Discounting and Macroeconomics
Lee, Donghyun N.
Lee, Donghyun N.
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Abstract
This dissertation comprises three chapters studying theoretical framework to numerical analysis in hyperbolic discounting preference (present bias), its impact on macroeconomics, and government’s policies to address one’s irrational decision and improve social welfare.
The first essay explores the effects of time-inconsistent preferences on wealth inequality in a classical money-in-utility model with heterogeneous agents and evaluates the role of paternalistic government policies in addressing inequality and improving welfare. I show that, in steady state, present bias exacerbates wealth inequality through its impact on interest rates and capital accumulation, particularly when heterogeneity exists in wealth formation across households. To address
behavioral inefficiencies caused by present bias, I propose policy design rules that target benchmark allocations. The combined implementation of paternalistic fiscal and monetary policies can correct individual inefficiencies induced by present bias. However, in the presence of heterogeneity, an additional type-dependent monetary transfer is necessary to replicate benchmark allocations due to varying degrees of distortion in the real money value across households. Numerical analysis confirms that the proposed policies reduce inequality and enhance welfare for both participant and non-participant types under both true (long-run) and choice-based (short-run) utility measures. In particular, under the short-run criterion, the policy is shown to be Pareto-improving. Welfare gains are larger for non-participants, who are more adversely affected by reduced capital accumulation due to their lack of access to capital markets. In contrast, participants benefit from a higher return on capital, making their steady-state deviation from the benchmark less severe.
The second chapter examines the effects of present bias on the deficit and inflation when the government finances the deficit using a seigniorage tax. I also examine how introducing present bias affects the welfare implications of the deficit in the long run. For this, I consider a three-period monetary overlapping generations (OLG) model with quasi-hyperbolic discounting preferences. I show that to finance a certain deficit level, the government should raise the seigniorage tax under present bias since the temptation of current consumption decreases aggregate money holdings. Thus, a higher inflation rate is observed in the hyperbolic discounting economy. I also demonstrate that the maximum sustainable deficit level at a steady state is lower in the hyperbolic discounting economy. Lastly, our local welfare analysis shows that the welfare cost of the deficit is higher for hyperbolic discounting consumers.
The third chapter investigates the formulation of government policies to achieve exponential discounting allocations within a hyperbolic discounting economy, utilizing a four-period overlapping generations model with altruistic parents. Conducted in a partial equilibrium framework, the study examines the impact of paternalistic policies, such as saving and education subsidies, on parent’s decisions. Findings indicate that a saving subsidy boosts fertility and removes the need for a bequest tax, while an education subsidy addresses the decline in human capital investment caused by the quantity-quality trade-off in children. The education subsidy should be more substantial than the saving subsidy to offset the negative impact of saving subsidy on education investment. Numerical analysis determines the suitable policy rates for different degrees of hyperbolic discounting and reveals significant and consistent welfare improvements. The results highlight the potential for targeted government interventions to enhance social welfare by correcting inefficiencies in hyperbolic discounting economies. Additionally, this paper explores the effects of the policies under endogenous interest rates, showing that the traditional quantity-quality trade-off may not hold. This highlights the need for further research in a general equilibrium setting, where endogenous price changes could alter the net impact of these policies, particularly in the context of endogenous economic growth by the accumulation of physical and human capital.
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Date
2025-01-01
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University of Kansas
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Keywords
Economics, Hyperbolic Discounting, Inequality, Inflation, Monetary and Fiscal Policy, Present Bias, Welfare