Time Preference and Macroeconomics

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The standard long run model of the macroeconomy-the neoclassical growth model- assumes a simple form of household preferences in which the rate of time preference is constant. However, some recent experimental evidence suggests that households are myopic in the sense that rates of time preference are very high over the near term but much lower between dates advanced some time in the future. This project will assess the theoretical implications of this form of preferences for observable macroeconomic behavior and then test the hypotheses on cross country data. The neoclassical growth model is modified to allow for a non constant rate of time preference. If the household cannot commit future choices of consumption and if utility is logarithmic, then an equilibrium is found that resembles the standard results of the neoclassical model. In this solution, the effective rate of time preference is high, but constant. Although this model has potentially important implications for institutional design and other policies- because households would benefit from an ability to commit future consumption-there is a sense in which the results are observationally equivalent to those of the conventional growth model. When the framework is extended to allow for partial commitment ability, then some testable hypotheses emerge. Steady state results are obtained for more general utility functions, and some properties of dynamic paths are worked out for the case of isoelastic utility. Further theoretical research will assess the uniqueness of the equilibria. Multiplicity of equilibria have been found in analogous contexts by other researchers but only when the household's horizon is infinite. The properties of the transitional dynamics will be worked out numerically for the case of isoelastic utility, and further testable hypotheses will be derived from the theory. The theory will also be linked with existing analyses that endogenize population growth and technological progress. Previous cross country empirical work on the determinants of economic growth will be extended to evaluate the macroeconomic significance of the kinds of time preference analysis that form the theoretical part of this research. The analysis will consider institutional and cultural elements that affect people's ability to make and enforce commitments. The institutional side will consider measures of the rule of law and political stability and other features of the legal environment that affect people's ability to organize financial markets and enter into contracts and other market relationships. The cultural side will assess aspects of religion, language, and ethnicity as possible influences on thrift, a propensity for honesty, and a willingness to work hard. In each case, the hypothesis to be tested is that the explanatory variables have joint influences across a group of dependent variables, including the rate of economic growth, the saving rate, the extent of financial market development, fertility decisions, and the intensity of investment in human capital ½ñ+¼^úá¼