Time Preference Shocks

The rate of time preference (RTP) has traditionally not been regarded as an important source of economic fluctuations. In this paper, I show that it is an important factor influencing economic fluctuations because households must have an expected RTP for the representative household (RTP RH) to behave optimally. Because it is impossible for a household to know the intrinsic RTP RH, it cannot know the parameters of the structural model of the RTP RH. Without a structural model, a household must use its beliefs to generate an expected RTP RH. As a result, the expected value can change more frequently than the intrinsic RTP RH. Because households often change their beliefs about their expected future paths, economic fluctuations caused by time preference shocks also can occur more frequently in an economy than previously thought.