Inflation attention and optimal decisions: Consumption/savings puzzle and asset prices

This paper investigates the inflation attention effect on consumption, savings, and portfolio choice for an individual. The individual is exposed to an uncertain inflation shock which can raise her inflation attention. The individual consumes and invests a constant fraction of her total wealth, but the heightened inflation attention results in a consumption cutback with savings increased. Using a general equilibrium analysis, we show that low consumption and high savings with the identified inflation risk premium results in a lower interest rate and higher equity premium. • We investigate the inflation attention effect on consumption, savings, and portfolio choice. • The increased inflation attention results in a consumption cutback with more savings. • We identify inflation risk premium resulting in a lower interest rate and higher equity premium.