In a model calibrated to match micro‐ and macroeconomic evidence on household income dynamics, we show that a modest degree of heterogeneity in household preferences or beliefs is sufficient to match empirical measures of wealth inequality in the United States. The heterogeneity‐augmented model's predictions are consistent with microeconomic evidence that suggests that the annual marginal propensity to consume (MPC) is much larger than the roughly 0.04 implied by commonly used macroeconomic models (even ones including some heterogeneity). The high MPC arises because many consumers hold little wealth despite having a strong precautionary motive. Our model also plausibly predicts that the aggregate MPC can differ greatly depending on how the shock is distributed across households (depending, e.g., on their wealth, or employment status).

To match aggregate consumption dynamics, macroeconomic models must generate “excess smoothness” in consumption expenditures. But microfounded models are calibrated to match micro data, which exhibit no “excess smoothness.” So standard microfounded models fail to match the macro smoothness facts. We show that the micro and macro evidence are both consistent with a microfounded model where consumers know their personal circumstances but have “sticky expectations” about the macroeconomy. Aggregate consumption sluggishness reflects consumers’ imperfect attention to aggregate shocks. Our proposed degree of inattention has negligible utility costs because aggregate shocks constitute a tiny proportion of the uncertainty that consumers face. (JEL D83, D84, E21, E23, E24)

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Forthcoming, International Journal of Central Banking. Thanks to the Consumer Financial Protection Bureau for funding the original creation of the Econ-ARK toolkit, whose latest version we used to produce all the results in this paper; and to the Sloan Foundation for funding Econ-ARK's extensive further development that brought it to the point where it could be used for this project. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. https://sloan.org/grant-detail/8071 NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.