Welfare implications of naive and sophisticated saving

Agents with declining discount rates who are unable to commit to their future decisions can either be sophisticated—meaning that they anticipate their future behavior and take it into account in their consumption choices—or naive. Previous studies have shown that sophistication may lead to higher or lower consumption rates, but have not resolved the implications for welfare, arguably the most important question from an economic point of view. Since neither the sophisticated nor the naive solutions are Pareto-efficient, their own welfare ranking is not obvious. This paper shows that the ‘better saver’ amongst the two (lower consumption rate) is always better-off, from all temporal perspectives.