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The rigidity of choice: Lifecycle savings with information-processing limits

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Author Info
Antonella Tutino
Abstract

This paper studies the implications of information-processing limits on the consumption and savings behavior of households through time. It presents a dynamic model in which consumers rationally choose the size and scope of the information they want to process concerning their financial possibilities, constrained by a Shannon channel. The model predicts that people with higher degrees of risk aversion rationally choose more information. This happens for precautionary reasons since, with finite processing rate, risk averse consumers prefer to be well informed about their financial possibilities before implementing a consumption plan. Moreover, numerical results show that consumers with processing capacity constraints have asymmetric responses to shocks, with negative shocks producing more persistent effects than positive ones. This asymmetry results in more savings. I show that the predictions of the model can be effectively used to study the impact of tax reforms on consumers spending.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-62.

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Date of creation: 2008
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Handle: RePEc:fip:fedgfe:2008-62

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Keywords: Consumption (Economics) ; Consumer behavior ; Saving and investment;

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  2. Aoki, Kosuke, 2003. "On the optimal monetary policy response to noisy indicators," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 501-523, April. [Downloadable!] (restricted)
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  6. Guido Lorenzoni, 2006. "Demand Shocks and Monetary Policy," Computing in Economics and Finance 2006 524, Society for Computational Economics.
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  8. Alvarez, Fernando & Stokey, Nancy L., 1998. "Dynamic Programming with Homogeneous Functions," Journal of Economic Theory, Elsevier, vol. 82(1), pages 167-189, September. [Downloadable!] (restricted)
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  10. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June. [Downloadable!]
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  12. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March. [Downloadable!]
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  16. Moscarini, Giuseppe, 2004. "Limited information capacity as a source of inertia," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 2003-2035, September. [Downloadable!] (restricted)
  17. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April. [Downloadable!] (restricted)
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  18. Peng, Lin, 2005. "Learning with Information Capacity Constraints," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(02), pages 307-329, June. [Downloadable!]
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  21. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December. [Downloadable!]
  22. Karen E. Dynan, 2000. "Habit Formation in Consumer Preferences: Evidence from Panel Data," American Economic Review, American Economic Association, vol. 90(3), pages 391-406, June. [Downloadable!] (restricted)
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  24. repec:fth:harver:1466 is not listed on IDEAS
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  26. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October. [Downloadable!] (restricted)
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