What we don’t know doesn’t hurt us: rational inattention and the permanent income hypothesis in general equilibrium

Yulei Luo (), Jun Nie, Gaowang Wang and Eric Young

No RWP 14-14, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003,2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that,under the assumption of CARA utility with Gaussian shocks, the permanent income hypothesis (PIH) arises in steady state equilibrium due to a balancing of precautionary savings and impatience. We then explore how RI affects the equilibrium joint dynamics of consumption, income and wealth, and find that elastic attention can make the model fit the data better. We finally show that the welfare costs of incomplete information are even smaller due to general equilibrium adjustments in interest rates.

Keywords: Rational inattention; Permanent income hypothesis; General equilibrium; Consumption and income volatility. (search for similar items in EconPapers)
JEL-codes: C61 D83 E21 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2014-11-01
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mfd and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.kansascityfed.org/documents/7723/rwp14-14.pdf (application/pdf)

Related works:
Working Paper: What We Don't Know Doesn't Hurt Us: Rational Inattention and the Permanent Income Hypothesis in General Equilibrium (2015)
Working Paper: What We Don't Know Doesn't Hurt Us: Rational Inattention and the Permanent Income Hypothesis in General Equilibrium (2014)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedkrw:rwp14-14

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Research Working Paper from Federal Reserve Bank of Kansas City Contact information at EDIRC.
Bibliographic data for series maintained by Zach Kastens ().