Consumption Wedges: Measuring and Diagnosing Distortions

Deviations from canonical consumption-savings models have been attributed to a wide range of distortions, including financial constraints and behavioral preferences. We develop a new sufficient statistics approach to measure the impact of such distortions on consumption as a micro-level wedge between actual consumption and a counterfactual ”frictionless” consumption. Our approach is applicable to a broad class of models and, unlike standard wedge measurement approaches, does not rely on an assumption of full-information rational expectations (FIRE), which allows us to isolate the influence of frictions and behavioral preferences from deviations from FIRE. Since different frictions imply different properties of wedges, the estimates of wedges can be used as a diagnostic to distinguish between models. To implement this approach, we field a new survey of economic beliefs, which we link to bank account transactions data for a population of predominantly middle-income US consumers with low liquid wealth. We find that consumption choices are significantly distorted both upward and downward. The median wedge is 52% of frictionless consumption in absolute value, with 75% having negative wedges (under-consuming) and 25% having positive wedges (over-consuming). Since financial constraints only generate negative wedges, additional or alternative distortions (such as present bias or consumer inertia) are necessary to rationalize the consumption decisions of low-liquidity households