Financial expectations, consumption and saving: A microeconomic analysis

Abstract

We explore the determinants of individuals' financial expectations using data from the British Household Panel Survey, 1991-2003. Our findings suggest that individuals' financial predictions are influenced by both the life cycle and the business cycle. We also investigate the extent to which the accuracy of past financial expectations affects current financial expectations. Regardless of the accuracy of the prediction, past financial optimism has a positive effect on current expectations formation whilst past financial pessimism has a negative effect. We also explore the relationship between financial realisations and expectations and we find that expectations tend to fall short of financial realisations. Finally, we investigate how financial expectations influence saving and consumption. Our findings suggest that financial optimism is inversely associated with saving and that current financial expectations serve to predict future consumption. © Institute for Fiscal Studies, 2006.