Mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities. Making use of research on this topic over the past decade, this paper summarizes the current state of our knowledge about how people engage in mental accounting activities. Three components of mental accounting receive the most attention. This first captures how outcomes are perceived and experienced, and how decisions are made and subsequently evaluated. The accounting system provides the inputs to be both ex ante and ex post cost-benefit analyses. A second component of mental accounting involves the assignment of activities to specific accounts. Both the sources and uses of funds are labeled in real as well as in mental accounting systems. Expenditures are grouped into categories (housing, food, etc.) and spending is sometimes constrained by implicit or explicit budgets. The third component of mental accounting concerns the frequency with which accounts are evaluated and 'choice bracketing'. Accounts can be balanced daily,

¤ This paper was prepared for inclusion in a symposium on saving and consumption in the Journal of Economic Perspectives. The authors thank, without implication, Timothy

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This paper provides a review of the theory of the determinants of individual and national thrift that has come to be known as the Life Cycle Hypothesis (LCH) of saving. Applications to some current policy issues are also discussed. Part I deals with the state of the art on the eve of the formulation of the LCH

We provide a new model of consumption-saving decisions which explicitly allows for internal commitment mechanisms and self-control. Agents have the ability to invoke either automatic processes that are susceptible to the temptation of ‘overconsuming,’ or alternative control processes which require internal commitment but are immune to such temptations. Standard models in behavioral economics ignore such internal commitment mechanisms. We justify our model by showing that much of its construction is consistent with dynamic choice and cognitive control as they are understood in cognitive neuroscience. The dynamic consumption-saving behavior of an agent in the model is characterized by a simple consumption-saving goal, a propensity to consume out of wealth which is independent of any realized temptation, and a cut-off rule for invoking control processes to inhibit automatic processes and implement the consumptionsaving goal. We compare the behavior induced by our model with that induced by standard behavioral models where agents have no internal commitment ability. We discuss empirical tests of our model with available individual consumption data and we suggest critical tests with brain-imaging and experimental data.

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In this paper, we present a quantitative analysis of international capital flows induced by differences in population aging processes across countries and by pension reforms. In the vast majority of countries, demographic change will continue well into the 21 st century. It is well known that within each country, demographic change alters the time path of aggregate savings, even more so in countries where fundamental pension reforms and shifts towards more pre-funding are implemented. While the patterns of population aging are similar in most countries, the timing differs substantially, in particular between industrialized and less developed countries. To the extent that capital is internationally mobile, population aging will therefore induce capital flows between countries. In order to quantify these effects, we develop a stylized multi-country overlapping generations model, and we use long-term demographic projections for several world regions to simulate international capital flows over a 50 year horizon. Our simulations suggest that capital flows from fast-aging industrial countries such as Germany to the rest of the world will be substantial. Closed-economy models of pension

Traditional mechanisms that spread mortality and longevity risk across a population group are increasingly being replaced by saving vehicles that leave this obligation in the hands of individual households. We explore the question of whether households are adequately saving for their future retirement by reviewing recent literature that examines household behavior in preparing for retirement – both in the accumulation phase and the decumulation phase – and by exploring representative households on the verge of retirement. While the median married couple of approximately fifty-five years of age holds assets totaling nearly $400,000, they still must engage in substantial saving to retire comfortably at age sixty-two.

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In this paper, it is shown that households who enter retirement with lower than ‘normal’ wealth do so because they had consistently followed near-sighted consumption rules during their working years. Using the Panel of Income Dynamics (PSID), household wealth in 1989 is predicted for a sample of 50-65 year old non-retired households using both current and past income, occupation, demographic and health characteristics. Using the residuals from this first stage regression, the sample of pre-retired households can be subsetted into households who save ‘lower ’ than predicted and all other households. By construction, these households had similar opportunities to save; the average household in both these sub-samples is identical along all observable income and demographic characteristics. It is then shown that households in the low wealth residual sample had much larger declines in consumption upon retirement. It appears that retirement came as more of a surprise to these households. In the main part of the paper, I use the panel component of the PSID and analyze the consumption behavior of these households early in their lifecycle. It is shown that these low pre-retirement wealth households had consumption growth that responded to predictable changes in income during their early working years. No such behavior was found among the other pre-retired households. Moreover, the low residual households responded both to predictable income increases as well as predictable income declines, a result that is inconsistent with a liquidity constraints explanation. After ruling out other theories of consumption to explain these facts, it is concluded that households who entered retirement with lower than predicted wealth followed some near-sighted consumption rule of thumb early in their working lives.