Consumption Commitments and Employment Contracts

Abstract

We examine an economy in which the cost of consuming some goods can be reduced by making commitments that reduce flexibility. We show that such consumption commitments can induce consumers with riskneutral underlying utility functions to be risk averse over small variations in income, but sometimes to seek risk over large variations. As a result, optimal employment contracts will smooth wages conditional on being employed, but may incorporate a possibility of unemployment.

Consumption Commitments and Habit Formation

“…Flavin and Nakagawa (2008) studied asset pricing in a two-good adjustment cost model and noted the similarity to habit. Fratantoni (2001) and Postlewaite, Samuelson, and Silverman (2008) also studied two-good models and noted this similarity in other contexts. We contribute to this literature by analyzing aggregate dynamics, presenting formal conditions under which commitments and habit formation are similar, and deriving new behavioral and welfare predictions that distinguish the two models (summarized in Section 5).…”

“…Such consumption commitments can amplify the welfare costs of shocks because-for shocks that are not large enough to induce a change in commitments-households are forced to concentrate all reductions in wealth on changes in adjustable (e.g., food) consumption. Through this mechanism, consumption commitments can help explain microeconomic evidence in domains ranging from wage rigidities (Postlewaite, Samuelson, and Silverman (2008)) to added-worker effects (Chetty and Szeidl (2007)), housing choices of couples (Shore and Sinai (2010)), and portfolio choice (Chetty and Szeidl (2014)).…”

“Why Not Settle Down Already?” a Quantitative Analysis of the Delay in Marriage

“…In our model, the effect of increased labor income volatility on the timing of marriage is partially influenced by the presence of consumption commitments. Therefore, this article contributes to the consumption commitment literature along the lines of Chetty and Szeidl (2007) and Postlewaite et al (2008). Chetty and Szeidl discuss how risk-averse agents can become even more risk averse in the presence of consumption commitments.…”

Commitment, Risk, and Consumption: Do Birds of a Feather Have Bigger Nests?

“…We show 21 This result is at the nexus of the precautionary saving, S-s adjustment, and consumption commitments literatures. The consumption commitments literature examines the impact of adjustment dynamics on risk aversion and not on prudence and the level of consumption (Chetty & Szeidl, 2007;Browning & Crossley, 2004;Postlewaite, Samuelson, & Silverman, 2006). The empirical literature on durable goods and S-s bands considers the impact of shocks on adjustment dynamics but not on the target level of consumption (Attanasio, 2000;Eberly, 1994;Bertola, Guiso, & Pistaferri, 2005).…”