Sticky Information Diffusion and the Inertial Behavior of Durable Consumption

This paper studies the aggregate dynamics of durable and nondurable consumption under sticky information diffusion (SID) due to noisy observations and slow learning within the permanent income framework. We show that SID can significantly improve the model’s predictions on the joint behavior of income, durable, and nondurable consumption at the aggregate level. Specifically, we find that SID can help generate (i) realistic smoothness in durable and nondurable consumption, (ii) the autocorrelation of durable consumption, and (iii) the contemporaneous correlation between durable and nondurable consumption. Furthermore, we show that incorporating a fixed cost into our SID model does a better job of reproducing the infrequent adjustments of durable consumption at the individual level and the slow adjustments at the aggregate level. ∗We thank Marios Angeletos, Geng Li, Jordan Rappaport, Tom Sargent, Chris Sims, Yi-Chang Tsai, Jonathan Willis, three anonymous referees, and seminar and conference participants at the Federal Reserve Bank of Kansas City, Federal Reserve Board, The University of Tokyo, The Hong Kong University of Science and Technology, Washington and Lee University, and the Midwest Macroeconomics Meetings for helpful comments, and Wei Li and Lisa Taylor for valuable research assistance. Luo thanks the General Research Fund (GRF) in Hong Kong for financial support. Young thanks the Bankard Fund for Political Economy at Virginia for financial support. The views expressed here are the opinions of the authors only and do not necessarily represent those of the Federal Reserve Bank of Kansas City or the Federal Reserve System. All remaining errors are our responsibility. †School of Economics and Finance, The University of Hong Kong, Hong Kong. E-mail: [email protected]. ‡Economic Research Department, Federal Reserve Bank of Kansas City. E-mail: [email protected]. §Department of Economics, University of Virginia, Charlottesville, VA 22904. E-mail: [email protected].