Elastic attention, risk sharing, and international comovements

Abstract

In this paper we examine the effects of elastic information-processing capacity (or elastic attention) proposed in Sims (2010) on international consumption and income correlations in a tractable small open economy (SOE) model with exogenous income processes. We find that in the presence of capital mobility in financial markets, elastic attention due to a fixed information-processing cost lowers the international consumption correlations by generating heterogeneous consumption adjustments to income shocks across countries facing different macroeconomic uncertainty. In addition, we show that elastic attention can improve the model’s predictions for the other key moments of the joint dynamics of consumption and income.