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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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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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  1. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2011. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 225-247, April.
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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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