DP16667 On the Possibility of Krusell-Smith Equilibria

Author(s): Tobias Broer, Alexandre Kohlhas, Kurt Mitman, Kathrin Schlafmann
Publication Date: October 2021
Date Revised: December 2021
Keyword(s): Expectations, Heterogeneity, Information
JEL(s): C53, D83, E30
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16667

Solutions to macroeconomic models with wealth inequality and aggregate shocks often rely on the assumption of limited but common information among households. We show that this assumption is inconsistent with rational information choice for plausible information costs. To do so, we embed information choice into the workhorse heterogeneous-agent model with aggregate risk (Krusell and Smith, 1998). First, we demonstrate that the benefits of acquiring more precise information about the state of the economy depend crucially on household wealth. Second, we show that such heterogeneous incentives to acquire information combine with the strategic substitutability of savings choices to imply that equilibria in which households acquire the same information do not exist for plausible information costs. Finally, we document that a representative-agent equilibrium may not exist even in the absence of exogenous sources of wealth heterogeneity.