Optimal Commitment and the Type of Temptation

The main purpose of this paper is to describe how different assumptions about temptation and self-control affect the optimal borrowing and saving contracts in a simple stochastic income setting. I find that the optimal savings plan when temptation is myopic consists of a mandatory minimum level of savings, while the optimal plan for farsighted temptation can have several fully restrictive mandatory savings levels, with only the highest being a mandatory minimum. When temptation is myopic money burning will never be part of an optimal separating contract, though it can be when temptation is farsighted. Also, when temptation is myopic an individual will strictly prefer mandatory deposits to liquidity constraints. Finally, I find that the optimal borrowing plan when self-control is costly consists of regular payments and self imposed debt limit.