What Is Time Inconsistent Behavior?
Time inconsistent behavior describes a situation in which a person's preferences change over time in a way that their future actions contradict their current plans or intentions. This concept is a cornerstone of behavioral economics, a field that explores how psychological factors influence decision making that deviates from purely rational choice theory. Essentially, an individual might formulate a rational plan for the future, but when that future arrives, immediate temptations or evolving circumstances lead them to act in a way that is inconsistent with their earlier goals. This often involves a conflict between one's present self and future self, where the immediate gratification offered by short-term rewards overrides the pursuit of long-term goals.
History and Origin
The concept of time inconsistency gained prominence in economics with the pioneering work of Robert Strotz in the mid-20th century. His 1956 paper, "Myopia and Inconsistency in Dynamic Utility Maximization," identified how individuals might deviate from optimal plans over time, even if their expectations about the future remain unchanged. Strotz laid the theoretical groundwork for understanding how individuals might lack commitment to their own pre-determined future actions. While Strotz focused on theoretical implications, later researchers, such as David Laibson, further developed the idea with the introduction of hyperbolic discounting, a specific form of time-inconsistent preferences where the present is weighted disproportionately more than future periods. This work highlighted how preferences can shift, causing individuals to prefer immediate rewards over larger, delayed rewards, a phenomenon explored in detail by the Federal Reserve Bank of San Francisco.5
Key Takeaways
- Time inconsistent behavior occurs when current plans for the future are abandoned later due to a shift in preferences or priorities.
- It is a core concept in behavioral economics, explaining deviations from traditional economic rationality.
- The phenomenon often stems from a stronger preference for immediate gratification over delayed benefits.
- Common manifestations include procrastination in financial planning and inadequate retirement savings.
- Understanding time inconsistency helps in designing strategies and policies to encourage more consistent decision-making.
Interpreting Time Inconsistent Behavior
Interpreting time inconsistent behavior involves recognizing the inherent tension between short-term desires and long-term objectives. It highlights that individuals may struggle with self-control when faced with immediate rewards, even if they understand the long-term consequences. This behavior suggests that people often value things happening "now" more intensely than things happening even a short time in the future. For example, a person might set a strict budget at the beginning of the month but then engage in impulse buying when confronted with an appealing sale. The shift in preference from "saving money" to "enjoying a new item immediately" illustrates this inconsistency. It underscores that human future utility calculations are not always stable or linear, particularly when immediate gratification is an option.
Hypothetical Example
Consider Sarah, a young professional who sets a goal setting plan to save $500 per month for a down payment on a house, which is a significant long-term goals. At the beginning of each month, she genuinely intends to transfer $500 to her savings account immediately after receiving her paycheck.
However, when her paycheck arrives, a new, enticing opportunity often arises. Perhaps a friend invites her on an impromptu weekend getaway, or there's a limited-time sale on a new gadget she's been eyeing. The immediate pleasure of the trip or the new device, valued highly in the present moment, outweighs her initial commitment to saving. She might tell herself, "I'll just spend $200 now and save $300 later," or "I'll make up for it next month." Yet, when "later" or "next month" arrives, new temptations appear, and she finds herself repeatedly deferring the full $500 contribution. This consistent pattern of deviating from her established savings goal, despite acknowledging its importance, is a classic illustration of time inconsistent behavior. She experiences a conflict between her "planning self" (who values future homeownership) and her "doing self" (who values immediate experiences or possessions), leading to a failure of delayed gratification.
Practical Applications
Time inconsistent behavior has widespread practical applications across various financial and economic domains. In personal finance, it helps explain why many individuals struggle with retirement savings, often prioritizing current consumption over future financial security. This behavioral tendency influences investment decisions, as investors might take on excessive short-term risks for quick gains, undermining long-term portfolio growth.4
For policymakers, understanding time inconsistency is crucial for designing effective interventions. Governments and financial institutions leverage insights from behavioral finance to encourage more consistent behaviors. For instance, "nudge" policies, such as automatic enrollment in retirement plans (e.g., 401(k)s), are designed to counteract individuals' tendency towards inertia and procrastination. By setting the default to participation, these policies make it easier for people to align their actions with their long-term interests, even if they exhibit time-inconsistent preferences. The Organisation for Economic Co-operation and Development (OECD) frequently examines how behavioral insights can be applied to improve pension policies, acknowledging the impact of such behaviors on individuals' financial well-being.3
Limitations and Criticisms
While time inconsistent behavior provides a powerful lens for understanding human decision-making, it is not without limitations or criticisms. Some scholars argue that its emphasis on irrationality can sometimes overlook situations where apparent inconsistencies might actually be rational responses to evolving information or unforeseen circumstances. Critics suggest that focusing too heavily on cognitive biases might lead to paternalistic policies, potentially overestimating individuals' need for external "nudges" and underestimating their capacity for self-correction or learning.2
Furthermore, the models used to describe time inconsistency, such as hyperbolic discounting, can be complex and may not fully capture the nuances of individual variability in preferences. There's also debate about the extent to which these behaviors are truly "inconsistent" versus simply reflecting different, but still rational, preferences at different points in time. Policies based on these insights, while often beneficial, must be carefully designed to avoid unintended consequences or to impose undue restrictions on individual autonomy. The Brookings Institution has explored the boundaries and appropriate applications of behavioral economics in government policy, highlighting the need for careful consideration of its limitations.1
Time Inconsistent Behavior vs. Present Bias
While closely related and often used interchangeably, "time inconsistent behavior" is the broader phenomenon, and "present bias" is a specific psychological mechanism that frequently causes it. Time inconsistent behavior describes any situation where a person's preferences for choices at different points in time are not constant, leading to a deviation from an earlier plan. This means if you planned to do 'X' in the future but, when the future arrives, you choose 'Y' instead, that's time inconsistent behavior.
Present bias, on the other hand, refers to the tendency to weigh immediate gratification more heavily than future rewards, even if the future reward is objectively larger or better. This strong preference for the present relative to any point in the future can lead directly to time inconsistency. For example, if someone plans to save money for retirement (a future reward) but then spends it on a new gadget today (an immediate reward), this is an instance of present bias causing time inconsistent behavior. The New York Times has explored this concept, illustrating how valuing today too much can lead to future costs.
FAQs
Why do people exhibit time inconsistent behavior?
People exhibit time inconsistent behavior often due to psychological factors like the allure of immediate gratification, difficulty with self-control, and a tendency to discount future rewards more steeply than present ones. The "present self" values immediate enjoyment, while the "future self" prioritizes long-term well-being, leading to a conflict.
Can time inconsistent behavior be overcome?
Yes, time inconsistent behavior can be mitigated through various strategies. These include using "commitment devices" that make it harder to deviate from a plan (e.g., locking up savings), setting clear goal setting, and leveraging "nudges" in policy design, such as automatic enrollment in retirement savings plans.
Is time inconsistent behavior always irrational?
Not necessarily. While it deviates from the strict rationality assumed in traditional economics, behavioral economists view time inconsistent behavior as a common aspect of human psychology. It highlights that individuals may not always act in ways that maximize their long-term utility, even when they know what is best for them.
How does time inconsistency affect personal finance?
In personal finance, time inconsistency can lead to inadequate savings, excessive debt from impulse buying, delayed investment decisions, and procrastination on important tasks like financial planning. It can undermine individuals' efforts to achieve their financial goals.
What is the difference between time inconsistent and time consistent preferences?
Time consistent preferences mean that a person's ranking of choices remains stable over time, irrespective of when the choice is made. In contrast, time inconsistent preferences mean that the ranking of choices changes as time passes, leading to a preference reversal where a plan made today is no longer preferred when the time for action arrives.