Short-term planning and the life-cycle consumption puzzle

We develop a new life-cycle consumption model where the individual has a short planning horizon. Standard life-cycle consumers with perfect foresight and 'hand-to-mouth' consumers are both special (limiting) cases of our model, where the length of the planning horizon is set to the entire lifetime and zero, respectively. We derive an analytical solution to the (time inconsistent) short-term planning problem, which reveals the inner workings of the model and facilitates its use in other settings. We also show that the short-term planning mechanism is powerful enough to generate a consumption hump with the right size and location.