"Selective Inattention", with Tim de Silva
Abstract: We introduce the concept of selective inattention: agents in the economy selectively update their expectations about aggregate variables only when they make individual decisions for which these variables are relevant. Using a comprehensive set of household surveys, we show that households form expectations of macroeconomic variables that are more accurate, less dispersed, and closer to those of professional forecasters around periods in which they make important decisions, such as taking out a mortgage. These effects are larger for more consequential decisions and increase with proxies for financial sophistication. In ongoing work, we develop a consumption-savings model with durable and nondurable consumption, where agents can pay an observation cost to observe the return on a risky asset. In the model, agents exhibit selective inattention endogenously: they are more likely to pay the observation cost when adjusting durable consumption. This selective inattention has spillover effects on nondurable consumption and implies that the model can exhibit two features that have been difficult to reconcile jointly: a high level of macro-inattention, which refers to the sluggishness with which average expectations respond to shocks, and large responses of macro aggregates to shocks, in particular volatile durable goods spending.
"Thinking about the Economy, Deep or Shallow?", with Lingxuan Wu
Abstract: An economy's responses to shocks are re-equilibrating processes involving many forces. How do people intuit them in forming expectations? We represent people's mental models of the economy using a directed graph. We develop a theory-informed survey and identify a novel pattern termed “shallow understanding” (SU): people grasp immediate implications better than further equilibrium relations. We further establish that the capacity to comprehend deep relations is an individual characteristic, which explains belief heterogeneity within the population. We propose a tractable integration of SU into a heterogeneous-agent New Keynesian (HANK) model and reassess policy transmission. Fiscal and monetary policy tools are more potent than under rational expectations when the Taylor rule is aggressive, and less potent when the Taylor rule is accommodative. Additionally, policy transmission is found to be less sensitive to the Taylor rule coefficient than suggested by rational expectations.
"The How and Why of Household Reactions to Income Shocks", with Stefanie Stantcheva and Roberto Colarieti
Abstract: This paper studies how and why households adjust their spending, saving, and borrowing in response to transitory income shocks. We leverage new large-scale survey data to first quantitatively assess households' intertemporal marginal propensities to consume (MPCs) and deleverage (MPDs) (the 'how'), and second to dive into the motivations and decision-making processes across households (the 'why). The combination of the quantitative estimation of household response dynamics with a qualitative exploration of the mental models employed during financial decisions provides a more complete view of household behavior. Our findings are as follows: First, we validate the reliability of surveys in predicting actual economic behaviors using a new approach called cross-validation, which compares the responses to hypothetical financial scenarios with observed actions from past studies. Participants' predicted reactions closely align with real-life behaviors. Second, we show that MPCs are significantly higher immediately following an income shock and diminish over time, with cumulative MPCs over a year showing significant variability. However, MPDs play a critical role in household financial adjustments and display significantly more cross-sectional heterogeneity. Neither is easily explained by socioeconomic or financial characteristics alone, and the explanatory power is improved by adding psychological factors, past experiences, and expectations. Third, using specifically-designed survey questions, we find that there is a broad range of motivations behind households' financial decisions and identify four household types using machine learning: Strongly Constrained, Precautionary, Quasi-Smoothers, and Spenders. Similar financial actions stem from diverse reasons, challenging the predictability of financial behavior solely based on socioeconomic and financial characteristics. Finally, we use our findings to address some puzzles in household finance.
"Debt and Austerity: International Evidence and the Case of Brazil" (2020), with Alberto Alesina, Cadernos de Finanças Públicas
"The Italian Public Debt" (2019), with Alberto Alesina, Carlo Favero and Francesco Giavazzi, in "Austerità" ed. Rizzoli
"Austerity and Public Debt Dynamics" (2019), with Carlo Favero, CEPR DP 14072