"Changing Tastes and Effective Consistency"
Working Paper,
2012
Publication type: Working paper
Abstract
In a simple single commodity certainty setting with changing tastes, a consumer’s consumption plan can be obtained using naive or sophisticated choice. Although in general these solutions diverge, they agree in the special case where the changing tastes are represented by discounted logarithmic utilities. We show more generally that this result does not require preferences to be logarithmic, additively separable, or homothetic. Sufficient conditions are provided for when naive and sophisticated choice agree and the common plan can be rationalized by a non-changing tastes utility. Because the solution generated by this utility is not revised over time, the plan is referred to as being effectively consistent. The optimal consumption plan for a popular form of quasi-hyperbolic discounted utility is shown to be rationalized by a non-changing tastes discounted utility which has a very different pattern of intertemporal discount rates. We also consider the implications of effective consistency for equilibrium interest rates in a standard representative agent term structure model.
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