Filip Rozsypal, Danmarks Nationalbank
"Overpersistence bias in individual income expectations and its aggregate implications"
Using micro level data, we document a systematic, income-related component in
household income forecast errors. These errors can be explained by a modest deviation
from rational expectations, where agents overestimate the persistence of their income
process. This bias has two effects. First, low income households with this bias are too
pessimistic and hence choose to borrow less than their fully rational counterparts even
though their borrowing constraint is not binding. This allows a quantitative model to
match the joint distribution of liquid assets and income. Second, the bias alters the
distribution of marginal propensities to consume which makes government stimulus
policies less effective.