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Bad Luck or Bad Decisions? Macroeconomic Implications of Persistent Heterogeneity in Cognitive Skills and Overconfidence

Discussion Papers 2080, 50 S.

Oliver Pfäuti, Fabian Seyrich, Jonathan Zinman


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Business cycle models often abstract from persistent household heterogeneity, despite its potentially significant implications for macroeconomic fluctuations and policy. We show empirically that the likelihood of being persistently financially constrained decreases with cognitive skills and increases with overconfidence thereon. Guided by this and other micro evidence, we add persistent heterogeneity in cognitive skills and overconfidence to an otherwise standard HANK model. Overconfidence proves to be the key innovation, driving households to spend instead of precautionary save and producing empirically realistic wealth distributions and hand-to-mouth shares and MPCs across the income distribution. We highlight implications for various fiscal policies.

Fabian Seyrich

Ph.D. Student in the Macroeconomics Department

JEL-Classification: D91;E21;E62;E71;G51
Keywords: Household heterogeneity, cognitive skills, overconfidence, financial constraints, fiscal policy, HANK