Present bias, mental budget constraint, and the payday consumption cycle

Abstract

This study investigates the phenomenon of household consumption rising and then dropping after payday, even in the absence of liquidity constraints. Utilizing data from a large bank, we document two findings that jointly provide a rationale for such payday consumption cycle. First, we find that consumption surges around payday only among groups exhibiting strong present bias. Second, we identify the presence of mental budget constraints, where a plausibly exogenous payday surge in consumption predicts a decrease in consumption three and four weeks later, even in the absence of liquidity constraints. These findings suggest that present bias together with mental budget constraints provide an explanation for the payday consumption cycle.