Researchers from Columbia Business School and Copenhagen Business School recently published a paper entitled ‘The Liquid Hand-to-Mouth: Evidence from Personal Finance Management Software’. The report has been published by publications such as the world renowned Review of Financial Studies.
Using aggregated spending, income, balances, and credit limits, in collaboration with Meniga’s Analytics team, researches investigated spending responses to the arrival of both regular and irregular income and provided a first-order contribution to our understanding of consumption choices.
Read the full paper here.
The conclusion derived by researchers Arna Olafsson, Copenhagen Business School and Michaela Page, Columbia Business School was that spending is significantly excessively sensitive to income payments. Payday spending is a completely understandable behavior from a common-sense standpoint but standard economic theory states that consumption should not respond to the timing of predictable changes in disposable income because people optimize their budgets across time.
So theoretically, you shouldn’t see people consuming more just because they have more money one day — yet it happens.
Historically economists have attributed payday spending to a lack of cash on hand, due either to a lack of savings, as among the working poor, or to wealth being tied up in houses, cars and investments, as among the more affluent.
However, Arna and Michaela show that these explanations are not empirically relevant and infer that a psychological response may cause people to spend on payday. Despite the fact the income is expected, the influx gives consumers a momentary feeling of being flush with cash, leading them to splurge on more, and pricier, goods.
Arna Olafsson researcher at Copenhagen Business School said “The findings suggest that there exists a powerful psychological reason to spend cash inflows. Thus, individuals do not inter-temporally optimize but instead use heuristics to decide how much to consume and save.
We remain agnostic about which environmental or preference-related theories drive hand-to-mouth behavior, and we assume that this behavior may be caused by any preference or cognitive, computational, and time limits of the household.
However, the results call attention to the the lack of rigorous, portable, and generally-applicable models of such behavior. The bottom line is that we cannot expect realistic predictions from economic models if their assumptions are not.”
Meniga has previously worked with the two Universities on a paper entitled ‘The Retirement-Consumption Puzzle: New Evidence from Personal Finances’ which concluded that retirees were more inclined to reduce consumer debt and increase their liquid savings.