Consumption, Saving, and Local Interaction

Dorothea K. Herreiner - University of Bonn

This paper endows a consumption model with a spatial information structure. Contrary to most existing models where consumption is determined by income and consumption values on the aggregate and/or the individual level, it is determined by the income and consumption process in the local neighbourhood. Each individual infers information about aggregate income changes from the observed changes in the neighbourhood and therefore adjusts only slowly. Consumption in any one period consists of a reaction to the current income shock and of a correction of the reaction to earlier income shocks. This leads to autocorrelation of consumption (excess sensitivity) and possibly to a lower variance in the changes of aggregate consumption than in the changes of aggregate income (excess smoothness). Simulations show how the relationship between the aggregate income and the aggregate consumption process depends on the individual consumption function (quadratic or CRRA type) and the neighbourhood structure of the economy.

Scheduled for Session 1.4 Evolutionary Models - I