analysing behavioural responses to policy change in dynamic decision environments

Analysing Behavioural Responses to Policy Change in Dynamic Decision

Environments

www.melbourneinstitute.com

Outline

Alternative Approaches to Policy Analysis SIDD: A Life-cycle Model of the Household

– Outline of the model– Solution methods– Using the model

On-Going Work Directions for the Future


Analyses of Policy

A continuum of behavioural assumptions

very broad behavioural assumptions

Back-of-an- envelope analysis

detailed statistical analysis

no formal model of behaviour

detailed statistical analysis

formal model of behaviour – uncertainty

omitted or poor accounted for

detailed numerical analysis

formal model of behaviour –

uncertainty explicitly accounted for


SIDD: a Household Life-cycle Model

Simulator of Individual Dynamic Decisions The unit of analysis is the household Households fully described by the following

characteristics (state variables):

• age • education status

• number of adults • number and age of children

• safe liquid assets • wage rates

• pension arrangements • time of death


SIDD: Outline

Households make decisions regarding the following (control) variables:

Uncertainty influences the following:

• consumption • labour supply

• pension scheme participation • pension contribution rates

• education participation

• number of adults • number and age of children

• wage rates • pension arrangements

• time of death


SIDD: Outline Objective function:

where:

– intertemporal budget constraint (the entire lifetime)

– potential labour income (the working lifetime)

, ,

, ,

1

1 1/1 1/

, , , , ,,

11 1/ 1 1/ 1 1/

, , 1, 1 , 1 , 1,

, max ,

max , ,

i t i t

i t i t

Tj t

t i t i t t j t t i j i jc l

j t

i t i t t t t i t i tc l

V w h E u c l

u c l E V w h

1

1 1/ 1/ 1 1/ 1 1/, , , ,,i t i t i t i tu c l c l

tttttt clhrwww )1(1

tttt lhh 1loglog 1


SIDD: Solving the Decision Problem

hT

wT

hT-1

wT-1

hT-2

wT-2

h1

w1



Final period, T:– Death at the end of the period is certain, and the

household is assumed to be retired• Hence the household consumes all remaining

wealth plus any pension income, cT = wT + yT

– The values of final period consumption, utility, and marginal utility, are calculated and stored.

yT

wT

yT

wT

yT

wT

cT VT du/dcT



In period T-1:– Two alternative approaches to solution:

1. for any internal solution, the Euler condition must be satisfied:

2. at the solution, expected lifetime utility must be maximised:

0'11

T

TTT c

urE

c

u

TTTc

T VEcuVT

1111

max



Since we know how alternative values of c will affect the state variables in the next period, we can also obtain Et[du/dct+1] from the previously calculated grid at age T.

11

TT c

uc

hT-1

wT-1

hT

wT

du/dcT

wT-1,hT-1

Tc

u

T

TTT c

urE

c

u'1

1

cT-1

This is a deterministic solution



hT

wT

hT-1

wT-1

hT-2

wT-2

h1

w1

time


Advantages and Disadvantages

Advantages– Behavioural responses are based on a structural

model and therefore free of the Lucas Critique– Fully takes into account endogeneity between

alternative decisions (eg fertility and labour)– Explicitly takes into account influence of uncertainty

Disadvantages– Numerically demanding (made less of problem with

advances in computing)– Behavioural responses depend upon the validity of

assumed model (advantages of bounded rationality)


SIDD: Using the Model The model has been designed so that its

parameters can be easily adjusted. These parameters include:– time preference for consumption

• allowance for myopia

– bequest motives – preferences for leisure– attitudes to risk– the tax structure– the pensions structure– the incidence of childcare costs


On-going Analyses

Quasi-hyperbolic discounting and retirement behaviour

Training and later-life learning in the UK The impact of Government plans for pension

reform in the UK Analysis of the influence of decision costs on

responses to tax incentives to save Extending the model to project population

cross-sections forward through time


Directions for the Future

Specific topics of short-term interest:– Introduce the model to Treasury in Australia– Training and education in Australia– Fertility and female labour supply decisions in

Australia Medium term objectives:

– Build in additional behavioural rigidities– Start building in macro-linkages

Others?

analysing behavioural responses to policy change in dynamic decision environments

Documents

structural model

modelthe model

decision problemfinal

decision problemhtwtht

decision problemin period

decision problemsince

lifetime utility

alternative decisions