Abstract
Individuals who have time-inconsistent preferences make plans for the future that reflect the best of intentions, but then they fail to follow through with their prior plans. We examine whether policies/programs that encourage more saving might be helpful to individuals with such behavioral biases to save more for retirement. We attempt to answer this question in a theoretically comprehensive way by considering a variety of savings policies, including unfunded Social Security, fully-funded Social Security, the Save More Tomorrow (SMarT) program of Thaler and Benartzi, and fully-funded savings subsidies. An innovation of our study is that we incorporate a credit market spread into our dynamic model of life-cycle decision making. The credit spread in our model is calibrated to match the sizes of spreads observed in the United States, namely that of prime borrowing, subprime borrowing, and no borrowing. We find that the effectiveness of alternative savings policies depends on the size of the credit market spread. For example, an individual who borrows at the prime rate typically fares better under Laissez Faire than by participating in a Social Security program or in a SMarT program. On the other hand, an individual with time-inconsistent preferences who borrows at high rates, or who cannot borrow at all, can benefit from participating in such savings policies/programs. Finally, the policy of a savings subsidy appears to be the most effective way to improve the well-being of individuals with time-inconsistent preferences, for any assumption about credit market access in our model.