Intertemporal Consumption Choices
Project Leaders: Miles Kimball and Matthew Shapiro
This project uses the graphical presentation of hypothetical spending choices in Internet interviews to gather information on individual’s rate of time preference and intertemporal elasticity of substitution. These two preference parameters are fundamental inthe economic theory of intertemporal consumption choice but are seldom measured directly in surveys. The goal of this research project is to develop a reliable and valid survey measure of these two preference parameters. The achievement of this goal relies heavily on the graphics and randomization capabilities ofInternet interviewing. The findings from this project are also applicable to the measurement of other economic preference parameters, such labor supply elasticities.
Progress Report on Previous Work (Part C)
In the initial grant period, questions with intertemporal consumption choiceswere included in the second and sixth wave of the American Life Panel. In a short battery of questions, respondents allocate amonthly income of $3,000 from age 50 to 80betweenmonthly spending in a pre-retirement (age 50 to 65) and a post-retirement period (age 65 to 80). Individuals can borrow before retirement to spend more than their income, but the interest costs reduce their spending after retirement. Alternately, individuals can save in before retirement and boost their spending above their income after retirement. The interest rate that governs the economic tradeoff between current and future consumption is varied implicitly across the questions. (See Kimball, Sahm, and Shapiro(2006) for a detailed description.) The slope of the consumption path that individuals choose reveals the relative weight they place on current versus future consumption (or time preference) and the degree to which their consumption pathchanges when the interest changes reveals their responsiveness to changes in the price of current versus future consumption (elasticity of intertemporal substitution).
To make quantitative inferences about the underlying preference parameters, this project uses thestandardeconomic model of consumption growth:
(1)
where r is the real interest rate, s is the elasticity of intertemporal substitution and ρ is the rate of time preference. Aninterest rate is embedded in each question and the respondent’s choice of a pre-retirement and post-retirement spending pair identifies their desired (and affordable) consumption growth rate. A series of hypothetical choicesmade at different interest rates is then used to back out the two preference parameterss and ρ.
The ALP experiments with three Internet formats for the intertemporal consumption questions and uses randomization in each format to isolate framing effects. The first format in the ALP is comparable to the questions fielded in Module K of the 1992 HRS and in the 1999 HRS Mailout. Barsky, Kimball, Juster, and Shapiro (1997) designed the questions for the HRS and analyzed the results from the 1992 HRS. At a given interest rate, individuals are asked to select their first and second choice out of five affordable pre-retirement and post-retirement consumption pairs. The survey instrument depicts the discrete choice set graphically with monthly spending bars for the two periods. The question series on the ALP also randomizesthe order of the interest rate and the presentation of the spending bars.In contrast, in the HRS Mailout each respondent receives the same presentation of the questions. The randomization in the ALP is designed to isolate question framing effects from true preferences and to encourage active decision-making in this complicated question. Kimball et al. (2006) compare the responses to the first question format in the second wave of the ALP with the responses to the1999 HRS Mailout and argue that the innovations in the Internet instrument are useful. In their preliminary analysis, the response patterns in the Internet survey are more sensible than in the mail survey and the Internet respondents appear to be more engaged in the questions.For example, as the interest rate increases from 0 to 13.8 percent – a substantial increase in the opportunity cost of current consumption – half of the Internet respondents choose a steeper consumption path (lowering current spending relative to future spending) versus only one-quarter of the mail respondents. The estimates obtained in Internet survey are also more in line with Euler equation estimates based on the time series of aggregate consumption than the estimates from the mail survey.
The other two formats of the intertemporal consumption questions in the ALP use Java-enabled graphics to make the trade-offs between current and future consumption even more salient. At each interest rate, respondents use their mouse to actively form their desired consumption path. In addition to the final choice, these versions track the decision process as respondents manipulate the instrument and experiment with different consumption paths. Additional cleaning of the data has delayed its formal analysis, but the comments provided by respondents at the end of the Internet interview suggest that this dynamic version of the question was more favorably received, even though its delivery involved more technical difficulties.
Current Research Plan (Part D)
The renewal of this research grant would enable further questions regarding intertemporal consumption choice to be developed and fielded on the ALP. The graphical delivery of the intertemporal choice questions and the relatively complicated choice setting requires substantial collaboration between the researchers and the programmer of the Internet instrument. More experience with graphical presentation in the Internet survey would yield technical and methodological improvements in this type of question. A third administration of intertemporal consumption questions in the ALP could also be used to assess the reliability of the responses and to investigate systematic changes in individuals’ preferences (particularly as their actual retirement approaches).
The intertemporal consumption questions could also be used to explore the mode and selection effects of the Internet interviewing in a complicated decision-setting. In the existing data, the same individuals do not respond in both the mail and Internet surveys, but the similarity of the questions in the ALP and the HRS Mailout does allow some scope to examine the average mode effects and selectivity of Internet respondents. The selection of more educated individuals in the Internet survey may have a particularly large impact on the responses in the intertemporal consumption questions which demand considerable cognitive skills and attention. The addition of the intertemporal consumption questions to the HRS Internet survey would also enable a within-person comparison of the mode effects.
Internet interviewing offers a unique environment for measuring the preferences that govern intertemporal consumption choice. Graphical presentation, particularly with extensive randomization, is technically infeasible or prohibitively costly in other survey modes. The inclusion of standard textual questions on intertemporal consumption choice in the ALP would also allow us to investigate the correspondence between preference measures based on the responses to graphical and textual questions.
There are three key directions in which to push the measurement of time preference and intertemporal substitution. First, we have so far constrained agents to flat consumption in the pre-retirement and post-retirement periods. This strict division of time in two periods is not a necessary restriction in the Internet survey instrument. In fact, individual’sconsumption choices might differ if they were allowed to choose a more flexible path of consumption over time. The Internet format is flexible enough to have respondents shapeacontinuous consumption path with a mouse rather than simply select their spending in two discrete periods.
Second, while we have documented the value of shifts in the choice set with the implicit interest rate as a mechanism to force people to make active choices rather than passively keeping the same consumption growth rate (see Section C.1.3.1), it is important to compare the power of this mechanism to the effects of simpler mechanisms, such as instructing respondents in the preamble to the question that “many people find that they want to change what they do in the new situation.”
Third, the time-preference/intertemporal substitution questions we have used so far have the bias that inaction from any cause can look like a low elasticity of intertemporal substitution. It is important to compare these results to results from questions in which inaction implies a high elasticity of intertemporal substitution. This can help separate out cognitive issues in understanding the question from the true underlying elasticity of intertemporal substitution. This can be achieved as follows: Instead of imposing an interest rate and asking for a consumption profile, we can impose a consumption profile and then find the implicit interest rate at which an agent would trade-off small amounts of money when starting from that consumption profile. To the extent that the expressed willingness to trade-off small amounts of money is relatively unaffected by the initial consumption profile, it would imply a high elasticity of intertemporal substitution.
The experience gained in the Internet survey with the preferences in intertemporal consumption choice is applicable to measuringother preference parameters, such as labor supply elasticities—including retirement-age elasticities. These parameters are of particular interest in the HRS which focuses on the determinants of retirement and has already fielded some labor supply questions in its core survey. Kimball and Shapiro (2006) show that HRS data on what people would do if they won a large lottery imply a large income effect on labor supply. Several important questions arise in the face of this preliminary data. First, while this suggests that people react strongly to income shocks, do they, in fact, respond strongly to the incentives implied by changes in the marginal (as opposed to average) wage? Second, do hypothetical choice tasks yield income and substitution effects that approximately cancel? Third, what happens when the size of a lottery or of a marginal wage change is varied—that is, “What is the dose-response mapping?” The flexibility of the Internet offers an excellent environment to investigate these questions and the lessons from the intertemporal choice questions on the effective presentation of a complicated decision would readily apply.