Households' Liquidity Constraint, Optimal Attention Allocation, and Inflation Expectations

We theoretically and empirically investigate the implications of heterogeneity in households' inflation expectations formation within an economy. We develop a rational inattention model in which households attempt to minimize the expected loss from insufficient bargain-hunting and inefficient inter-temporal consumption allocation. The model focuses on households' allocation of attention to two variables: the cheapest price of a particular product they can find, and the inflation rate the central bank aims to achieve in the long run. The model yields the clear prediction that households with a tighter liquidity constraint will allocate more attention to finding the cheapest price of a good by visiting different stores and less attention to information on the inflation rate the central bank aims to achieve in the long run including messages sent out by the central bank. Using a unique and rich micro dataset of Japanese households, we find empirical support for the testable prediction of our model. The model provides the important policy implication that households pay more attention to messages emitted by the central bank if monetary easing successfully relieves households' liquidity constraints.