Two-stage Budgeting with Bounded Rationality

Nick Pretnar, Christopher Y. Olivola and Alan Montgomery

MPRA Paper from University Library of Munich, Germany

Abstract: We construct a unifying theory of two-stage budgeting and bounded rationality with mental accounting features. Mental accounting and rational inattention induce behavioral wedges between first-stage and second-stage expenditure budgets. Because reviewing one’s financial activities is cognitively costly, consumers might reassess only a subset of their spending budgets every period. Over- or under-spending affects future budgeting and expenditure decisions. We apply latent Bayesian inference to agent-level weekly expenditure data in order to structurally estimate the degree to which low-income consumers appear rationally constrained with respect to budgeting. Our findings provide insight into how consumers may respond to interventions that encourage more disciplined budgeting behavior, like push notifications in budgeting apps. If consumers are acutely aware of budget misses, they may adjust budgets upward to avoid the dis-utility of over-expenditure, driving savings rates and balances downward. In this manner, push notifications that warn consumers about budget thresholds could backfire and actually lead to budgeting behavior that reduces savings and wealth in the long-run.

Keywords: budgeting; mental accounting; bounded rationality; expenditure; savings (search for similar items in EconPapers)
JEL-codes: D11 D12 D91 (search for similar items in EconPapers)
Date: 2021-01-15
New Economics Papers: this item is included in nep-cbe and nep-upt
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https://mpra.ub.uni-muenchen.de/112810/1/MPRA_paper_105356.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:105356

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