(1) excess sensitivity puzzle:
If one follows an average household over its life cycle, two main stylized facts
emerge (see Attanasio (1999) for the detailed figures). First, disposable income
follows a hump over the life cycle, with a peak around the age of 45 (the age of
the household is defined by the age of the household head). This finding is hardly
surprising, given that at young ages households tend to obtain formal education
or training on the job and labor force participation of women is low because
of child bearing and rearing. As more and more agents finish their education
and learn on the job as well as promotions occur, average wages within the
cohort increase. Average personal income at age 45 is almost 2.5 times as highas average personal income at age 25. After the age of 45 personal income first
slowly, then more rapidly declines as more and more people retire and labor
productivity (and thus often wages) fall. The average household at age 65 has
only 60% of the personal income that the average household at age 45 obtains.
The second main finding is the surprising finding. Not only personal income,
but also consumption follows a hump over the life cycle. In other words, consumption
seems to track income over the life cycle fairly closely. This is one
statement of the so-called excess sensitivity puzzle: consumption appears
to be excessively sensitive to predicted changes in income. In fact, the two
standard theories of intertemporal consumption allocation we will consider in
the next section both predict that (under specific assumptions spelled out explicitly
below) consumption follows a martingale and current income does not
help to forecast future consumption. The hump-shaped consumption age pro-
…le apparently seems to contradict this hypothesis. Later in the course we will
investigate whether, once we control for household size (which also happens to
follow a hump shape), the hump-shape in consumption disappears or whether
the puzzle persists.
(2). Excess Smoothness Puzzle:
if the stochastic income process of households
is only di¤erence stationary (say, it follows a random walk) then a shock to
current income translates (more than) one to one into a shock to permanent
income and hence should induce a large shock to consumption. With
di¤erence-stationary income processes consumption should be as volatile
as current income, but we saw that, at least on the aggregate level, consumption
is smoother than income. Is in fact consumption “too smooth”.
This is the excess smoothness puzzle
(3). Lack of Decumulation Puzzle:
Household level wealth data show that a
significant fraction of very old households still hold a large portfolio of
financial and real estate assets. Why don’t these households decumulate
their assets and enhance their consumption, as standard life-cycle theory
predicts?
(4). Drop of Consumption Puzzle:
As people retire, their consumption drops by about 15% on average.
(5). Portfolio Allocation Puzzle:
The median wealth US household does not
own stocks, but holds its major fraction of the wealth portfolio concentrated
in its own home and the rest in low-return checking or savings
accounts. This is despite the fact that returns to equity and returns to
human capital (i.e. the households’ wage) are roughly uncorrelated for
this fraction of the population. In addition, Gross and Souleles (2000)
document that a signi…cant fraction of the population has simultaneously
high-interest credit card debt and liquid, low return assets such as a signifi
cantly positive checking account balance.
(6). Default Puzzle:
the US legal system allows private households to file for
personal bankruptcy under Chapter 7 or Chapter 11 of the US Bankruptcy
Code. In particular, under Chapter 7 households are discharged of all their
debts, are not required to use any of their future labor income to repay
the debt and can even keep their assets (financial or real estate) below a
state-dependent exemption level. Whereas about 1% of all households per
year file for personal bankruptcy, White (1998) computes that currently
at least 15% of all US households would financially benefit from filing for
bankruptcy.
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