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Business Cycle Dynamics under Rational Inattention

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  • Mackowiak, Bartosz Adam
  • Wiederholt, Mirko

Abstract

This paper develops a dynamic stochastic general equilibrium model with rational inattention. Households and decision-makers in firms have limited attention and decide how to allocate their attention. The paper studies the implications of rational inattention for business cycle dynamics. Impulse responses in the model have several properties of empirical impulse responses. Prices respond slowly to monetary policy shocks, faster to aggregate TFP shocks, and very quickly to disaggregate shocks. Therefore, profit losses due to deviations of the actual price from the profit-maximizing price are an order of magnitude smaller than in the Calvo model that generates the same real effects. Consumption responds slowly to aggregate shocks. For standard parameter values, deviations from the consumption Euler equation are cheap in utility terms, implying that households devote little attention to the consumption-saving decision and react slowly to changes in the real interest rate.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7691.

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Date of creation: Feb 2010
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Handle: RePEc:cpr:ceprdp:7691

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Keywords: Business Cycles; Dynamic Stochastic General Equilibrium; Information Choice; Monetary Policy; Rational Inattention;

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References

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  1. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  2. Midrigan, Virgiliu, 2006. "Menu costs, multi-product firms, and aggregate fluctuations," CFS Working Paper Series 2007/13, Center for Financial Studies (CFS).
  3. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  4. 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.
  5. Bartosz Mackowiak & Mirko Wiederholt, 2008. "Business Cycle Dynamics under Rational Inattention," 2008 Meeting Papers 1059, Society for Economic Dynamics.
  6. 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.
  7. Alejandro Justiniano & Giorgio E. Primiceri, 2006. "The Time Varying Volatility of Macroeconomic Fluctuations," NBER Working Papers 12022, National Bureau of Economic Research, Inc.
  8. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Harvard Institute of Economic Research Working Papers 1922, Harvard - Institute of Economic Research.
  9. Boivin, Jean & Giannoni, Marc & Mihov, Ilian, 2007. "Sticky Prices and Monetary Policy: Evidence from Disaggregated US Data," CEPR Discussion Papers 6101, C.E.P.R. Discussion Papers.
  10. Bartosz Maćkowiak & Mirko Wiederholt, 2009. "Optimal sticky prices under rational inattention," Working Paper Series 1009, European Central Bank.
  11. Antonella Tutino, 2008. "The rigidity of choice: Lifecycle savings with information-processing limits," Finance and Economics Discussion Series 2008-62, Board of Governors of the Federal Reserve System (U.S.).
  12. Laurence Ball & David Romer, 1990. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
  13. Marcin Kacperczyk & Stijn Van Nieuwerburgh & Laura Veldkamp, 2009. "Rational Attention Allocation Over the Business Cycle," NBER Working Papers 15450, National Bureau of Economic Research, Inc.
  14. Christopher D. Carroll & Jirka Slacalek & Martin Sommer, 2008. "International Evidence On Sticky Consumption Growth," CFS Working Paper Series 2008/09, Center for Financial Studies.
  15. Christian Hellwig & Laura Veldkamp, 2009. "Knowing What Others Know: Coordination Motives in Information Acquisition," Review of Economic Studies, Oxford University Press, vol. 76(1), pages 223-251.
  16. Paciello, Luigi, 2009. "Monetary Policy Activism and Price Responsiveness to Aggregate Shocks under Rational Inattention," MPRA Paper 16407, University Library of Munich, Germany.
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  19. repec:bla:restud:v:76:y:2009:i:1:p:223-251 is not listed on IDEAS
  20. Venky Venkateswaran & Christian Hellwig, 2009. "Setting The Right Prices for the Wrong Reasons," 2009 Meeting Papers 260, Society for Economic Dynamics.
  21. Luigi Paciello, 2008. "The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention," EIEF Working Papers Series 0816, Einaudi Institute for Economic and Finance (EIEF), revised Nov 2007.
  22. Filip Matejka, 2010. "Rationally Inattentive Seller: Sales and Discrete Pricing," CERGE-EI Working Papers wp408, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  23. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  24. Stijn Van Nieuwerburgh & Laura Veldkamp, 2008. "Information Acquisition and Under-Diversification," NBER Working Papers 13904, National Bureau of Economic Research, Inc.
  25. Pete Klenow & Ben Malin & Mark Bils, 2010. "Reset Price Inflation and the Impact of Monetary Policy Shocks," 2010 Meeting Papers 1079, Society for Economic Dynamics.
  26. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  27. Mirko Wiederholt & Emanuel Moench & Bartosz Maćkowiak, 2009. "Sectoral Price Data and Models of Price Setting," 2009 Meeting Papers 666, Society for Economic Dynamics.
  28. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-84, December.
  29. Mirko Wiederholt, 2010. "rational inattention," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
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  1. Business cycle dynamics under rational inattention
    by Christian Zimmermann in NEP-DGE blog on 2011-05-02 16:13:59
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