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Rational inattention and the dynamics of consumption and wealth in general equilibrium

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

Journal of Economic Theory, 2017, vol. 172, issue C, 55-87

Abstract: We propose a recursive utility version of a basic Huggett (1993) model to study the implications of rational inattention (or RI, Sims, 2003, 2010) for the cross-sectional dispersion of consumption and wealth (relative to income) in general equilibrium. We find that incorporating RI can significantly improve the model's predictions in both dimensions in general equilibrium. In addition, we find that intertemporal substitution plays an important role in determining the two key dispersion moments via affecting the degree of optimal attention in equilibrium. Finally, we show that alternative models that rely on habit formation, incomplete information about current income, or borrowing constraints are not consistent with the facts we document.

Keywords: Rational inattention; General equilibrium; Consumption and wealth dispersion (search for similar items in EconPapers)
JEL-codes: C61 D83 E21 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.jet.2017.08.005

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