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Processing savings and work decisions through Shannon's channels

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Author Info
Tutino, Antonella
Abstract

This paper argues that constraining people to choose consumption and labor under fi nite Shannon capacity produces results in line with U.S. business cycle data as well as secular movements in consumption and labor supply. The model has a simple partial equilibrium setting in which risk averse consumers keep high labor supply and low consumption profi le at early stage of life to hedge against wealth fluctuations. They rationally choose to keep consumption and labor unchanged until they collect enough information. I fi nd that at high frequency consumption appears to be more sluggish than labor supply. However, when people decide to change consumption they do so by a large amount. This combination leads to higher variance of consumption with respect to labor supply. The model also finds high persistence and strong comovement of consumption and employment and delayed response of consumption and labor with respect to shocks to wages. Positive changes in wages generate an increase in long run value of consumption while the change in long run values of labor is negligible. Furthermore, the effects on labor and consumption of a shock to wages propagate slowly over time due to people's endogenous choice of information. These findings suggest that rational inattention offers a promising avenue to bridge the gap between theory and U.S. data at business cycle frequency as well as in the long run.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16746.

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Date of creation: 22 May 2008
Date of revision: 26 Jul 2009
Handle: RePEc:pra:mprapa:16746

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Related research
Keywords: Savings and labor decisions; Shannon capacity; US business cycle;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
C63 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computational Techniques
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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  8. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 61(3), pages 397-415, July. [Downloadable!] (restricted)
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  9. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April. [Downloadable!] (restricted)
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  12. Mankiw, N Gregory, 1989. "Real Business Cycles: A New Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 79-90, Summer. [Downloadable!] (restricted)
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  13. Mankiw, N Gregory & Rotemberg, Julio J & Summers, Lawrence H, 1985. "Intertemporal Substitution in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 225-51, February. [Downloadable!] (restricted)
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  14. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-85, December. [Downloadable!] (restricted)
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