Informational Frictions, Induced Uncertainty, and Aggregate Wealth Accumulation∗

In this paper we examine implications of model uncertainty due to robustness (RB) for consumption, welfare, and aggregate savings under limited informationprocessing capacity (rational inattention or RI) in an otherwise standard permanent income model with filtering. We first solve the robust permanent income models with inattentive consumers and show that RI by itself creats an additional demand for robustness that leads to higher “induced uncertainty” facing consumers. Second, we explore how the induced uncertainty composed by (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects the model’s dynamics, precautionary savings, and welfare. Furthermore, we revisit the observational equivalence between RB and risk-sensitivity (RS) in this filtering problem. Finally, we quantitatively evaluate the relative importance of induced uncertainty and fundamental uncertainty on aggregate savings, and find that induced uncertainty not only affects precautionary savings but also nonprecautionary savings. ∗We would like to thank Richard Dennis, Larry Epstein, Hanming Fang, Ken Kasa, Tasos Karantounias, Jun Nie, Kevin Salyer, Tom Sargent, Martin Schneider, Chris Sims, Wing Suen, Laura Veldkamp, Cheng Wang, Mirko Wiederholt, and Tao Zhu as well as seminar and conference participants at UC Davis, The Hong Kong University of Science and Technology, City University of Hong Kong, University of Toyko, Shanghai University of Finance and Economics, the conference on “Putting Information Into (or Taking it out of) Macroeconomics” organized by LAEF of UCSB, the Summer Meeting of Econometric Society, the conference on “Rational Inattention and Related Theories” organized by CERGE-EI, Prague, the KEA annual meeting, and Fudan Conference on Economic Dynamics for helpful discussions and comments. Luo thanks the General Research Fund (GRF) in Hong Kong and the HKU seed funding program for basic research for financial support. All errors are the responsibility of the authors. †School of Economics and Finance, University of Hong Kong, Hong Kong. Email address: [email protected]. ‡Department of Economics, University of Virginia, Charlottesville, VA 22904. E-mail: [email protected].