A government policy with time-inconsistent consumers

Abstract

This paper examines monetary and fiscal policies to prevent consumers' present bias by implementing a benchmark exponential discounting allocation in a hyperbolic discounting economy. We analyze classical money-in-the-utility-function models and establish that a monetary policy alone cannot curb behavioral mistakes. Instead, it needs to be combined with either a consumption tax or capital tax. If the government uses consumption (capital) tax, the monetary policy should be more expansionary (contractionary) compared to the benchmark exponential discounting economy. In the calibration, we confirm that a paternalistic policy intervention generates significant welfare gains based on both true (long-run) and choice (short-run) utility.

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