DP5053 Inattentive Consumers

Author(s): Ricardo Reis
Publication Date: May 2005
Keyword(s): bounded rationality, consumption, excess sensitivity, excess smoothness, hand-to-mouth consumers, inattentiveness
JEL(s): D1, D8, D9, E2
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5053

This paper studies the consumption decisions of agents who face costs of acquiring, absorbing and processing information. These consumers rationally choose to only sporadically update their information and re-compute their optimal consumption plans. In between updating dates, they remain inattentive. This behaviour implies that news disperses slowly throughout the population, so events have a gradual and delayed effect on aggregate consumption. The model predicts that aggregate consumption adjusts slowly to shocks, and is able to explain the excess sensitivity and excess smoothness puzzles. In addition, individual consumption is sensitive to ordinary and unexpected past news, but it is not sensitive to extraordinary or predictable events. The model further predicts that some people rationally choose to not plan, live hand-to-mouth, and save less, while other people sporadically update their plans. The longer are these plans, the more they save. Evidence using US aggregate and microeconomic data generally supports these predictions.