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Rational Inattention and Aggregate Fluctuations

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  • Yulei Luo

    (University of Hong Kong)

  • Eric R. Young

    (University of Virginia)

Abstract

This paper introduces the rational inattention hypothesis (RI) -- that agents process information subject to finite channel constraints -- into a stochastic growth model with permanent technology shocks. We find that RI raises consumption volatility relative to output by introducing an endogenous demand shock. Furthermore, it is shown that incorporating RI can provide an additional internal propagation mechanism (measured by the impulse response function and the autocorrelation function of output growth) and generate higher variance of forecastable movements in output. However, we find that RI cannot resolve these puzzles in the RBC literature -- weak internal propagation and low variance of forecastable movements in output, even with what appears to be a very low capacity channel.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 9 (2009)
Issue (Month): 1 ()
Pages: 14

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Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:14

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Related research

Keywords: rational inattention; consumption volatility; propagation mechanism;

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References

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Citations

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Cited by:
  1. Luigi Paciello, 2012. "Monetary Policy and Price Responsiveness to Aggregate Shocks under Rational Inattention," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1375-1399, October.
  2. Yulei Luo, 2008. "Consumption Dynamics under Information Processing Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(2), pages 366-385, April.
  3. Yulei Luo, 2006. "Rational Inattention, Portfolio Choice, and the Equity Premium," Computing in Economics and Finance 2006 56, Society for Computational Economics.
  4. Eric R. Young & Yulei Luo, 2008. "Risk-sensitive Consumption and Savings under Rational Inattention," 2008 Meeting Papers 64, Society for Economic Dynamics.
  5. Alisdair McKay & Filip Matejka, 2011. "Rational Inattention to Discrete Choices: A New Foundation for the Multinomial Logit Model," 2011 Meeting Papers 535, Society for Economic Dynamics.
  6. Levine, Paul, 2010. "Monetary policy in an uncertain world: Probability models and the design of robust monetary rules," Working Papers 10/72, National Institute of Public Finance and Policy.
  7. Martins, Guilherme & Sinigaglia, Daniel, 2009. "Real Business Cycle Dynamics under Rational Inattention," MPRA Paper 14089, University Library of Munich, Germany.
  8. Yulei Luo, 2005. "Consumption Dynamics, Asset Pricing, and Welfare Effects under Information Processing Constraints," 2005 Meeting Papers 345, Society for Economic Dynamics.
  9. Paul Levine & Joseph Pearlman & Bo Yang, 2012. "Imperfect Information, Optimal Monetary Policy and Informational Consistency," School of Economics Discussion Papers 1012, School of Economics, University of Surrey.
  10. Luo, Yulei & Young, Eric R., 2010. "Asset pricing under information-processing constraints," Economics Letters, Elsevier, vol. 107(1), pages 26-29, April.
  11. Paul Levine, 2012. "Policy focus: Monetary policy in an uncertain world: probability models and the design of robust monetary rules," Indian Growth and Development Review, Emerald Group Publishing, vol. 5(1), pages 70-88, April.

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