Sticky Expectations and Consumption Dynamics by Jiri Slacalek, ECB

Since Campbell and Deaton (1989) macroeconomists have known that aggregate consumption exhibits “excess smoothness” compared to benchmark models. But a large literature has found no evidence of such smoothness in microeconomic data for individual households. We show that the conflict can be explained by a model in which consumers have accurate knowledge of their personal circumstances but ‘sticky expectations’ about the macroeconomy. In our model, the persistence of aggregate consumption growth reflects consumers’ imperfect attention to aggregate shocks. Our proposed degree of (macro) inattention has negligible utility costs, because aggregate shocks constitute only a tiny proportion of the uncertainty that consumers face. In contrast with models in the existing literature, our model is consistent with both micro and macro stylized facts about consumption dynamics.