This paper studies the macroeconomic consequences of consumers’ incomplete information about inflation. To do so, I extend the benchmark New Keynesian model by assuming that consumers rely on noisy information from their shopping experiences to form beliefs about inflation. In other words, I assume they learn by shopping. I show that this information friction anchors households’ beliefs about inflation. However, the degree of anchoring is endogenous and depends on the model’s structural features, including the monetary policy stance. Learning by shopping propagates the impact of demand shocks on output, even when prices are flexible. Price stickiness exacerbates this propagation, and the interaction of both frictions can be larger than the sum of the effects of each friction considered in isolation. Moreover, learning by shopping makes the slope of the Phillips curve a function of the degree of anchoring. For this reason, a more hawkish monetary policy can simultaneously anchor households’ inflation expectations, flatten the Phillips curve, and lower the volatility and persistence of inflation. The model suggests that such a policy also changed the drivers of the business cycle: It reduced the impact of supply shocks on aggregate output and made it more sensitive to exogenous shifts in aggregate demand.

This paper introduces the random discounted expected utility (RDEU) model, which we have developed as a means to deal with heterogeneous risk and time preferences. The RDEU model provides an explicit linkage between preference and choice heterogeneity. We prove that it has solid comparative statics and also demonstrate its computational convenience. Finally, we illustrate the empirical implementation of this model using two distinct experimental datasets.

Deleveraging shocks that increase household precautionary savings, and financial and uncertainty shocks to firms, interact and amplify each other, even when these same shocks separately have moderate effects on output and employment. This result is obtained in a model in which heterogeneous households face financial frictions and unemployment risk and in which heterogeneous firms borrow funds using nominally fixed long-term debt and face costly bankruptcy. This novel amplification mechanism is based on a dynamic feedback between the precautionary behavior of households and the bankruptcy and entry decisions of firms. Our results support the view that firm financial frictions are important to understand the effect of household deleveraging on unemployment, consistent with recent empirical studies examining the 2007-2009 Great Recession.