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The rigidity of choice: lifetime savings under information-processing constraints

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Author Info
Tutino, Antonella
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 about their fi nancial possibilities, constrained by a Shannon channel. The model predicts that people with higher degrees of risk aversion rationally choose higher information. This happens for precautionary reasons since, with fi nite processing rate, risk averse consumers prefer to be well informed about their fi nancial possibilities before implementing 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 into more savings. I show that the predictions of the model can be effectively used to study the impact of tax reforms on consumers spending. The results are qualitatively consistent with the evidence on tax rebates (2001, 2008).

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16744.

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Date of creation: 21 Jun 2008
Date of revision: 24 Jul 2009
Handle: RePEc:pra:mprapa:16744

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Related research
Keywords: Consumption; Rational Inattention; Dynamic programming;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information

References listed on IDEAS
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  1. Garcia, Rene & Lusardi, Annamaria & Ng, Serena, 1997. "Excess Sensitivity and Asymmetries in Consumption: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(2), pages 154-76, May.
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  2. Sims, Christopher A., 2005. "Rational inattention: a research agenda," Discussion Paper Series 1: Economic Studies 2005,34, Deutsche Bundesbank, Research Centre. [Downloadable!]
  3. George-Marios Angeletos & Alessandro Pavan, 2004. "Transparency of Information and Coordination in Economies with Investment Complementarities," American Economic Review, American Economic Association, vol. 94(2), pages 91-98, May. [Downloadable!]
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  4. Jonathan A. Parker, 1999. "The Reaction of Household Consumption to Predictable Changes in Social Security Taxes," American Economic Review, American Economic Association, vol. 89(4), pages 959-973, September. [Downloadable!] (restricted)
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  7. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April. [Downloadable!] (restricted)
  8. Campbell, John Y & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Review of Economic Studies, Blackwell Publishing, vol. 56(3), pages 357-73, July. [Downloadable!] (restricted)
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  10. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April. [Downloadable!] (restricted)
  11. 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)
  12. Jordi Mondria, 2006. "Financial Contagion and Attention Allocation," 2006 Meeting Papers 177, Society for Economic Dynamics. [Downloadable!]
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  13. John H. Cochrane, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," NBER Working Papers 2730, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Kurt F. Lewis, 2008. "The two-period rational inattention model: accelerations and analyses," Finance and Economics Discussion Series 2008-22, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Reis, Ricardo, 2006. "Inattentive consumers," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1761-1800, November. [Downloadable!] (restricted)
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  16. Henry Kim & Jinill Kim & Ernst Schaumburg & Christopher A. Sims, 2005. "Calculating and Using Second Order Accurate Solutions of Discrete Time Dynamic Equilibrium Models," Discussion Papers Series, Department of Economics, Tufts University 0505, Department of Economics, Tufts University. [Downloadable!]
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  17. Christopher D. Carroll, 2003. "Macroeconomic Expectations Of Households And Professional Forecasters," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 269-298, February. [Downloadable!] (restricted)
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