Can Behavioral Models Explain the Puzzles?
There are certainly many good behavioral models that shed light on the consumption puzzles. For instance, to produce an increase in MPC when the size of windfall income shocks decreases, the so-called mental accounting models do a good job (for example, Thaler, 1992). Costly self-control also provides a good explanation. If self-control is costly, it is worthwhile to exert self-control only when the temptation to consume (windfall income) is large (see Benhabib and Bisin 2002). However, I do not pursue these behavioral approaches in this paper.
