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The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention

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  • Luigi Paciello

    (Northwestern University and EIEF)

Abstract

The speed of inflation adjustment to aggregate technology shocks is substantially larger than to monetary policy shocks. Prices adjust very quickly to technology shocks, while they only respond sluggishly to monetary policy shocks. This evidence is hard to reconcile with existing models of stickiness in prices. I show that the difference in the speed of price adjustment to the two types of shocks arises naturally in a model where price setting firms optimally decide what to pay attention to, subject to a constraint on information flows. In my model, firms pay more attention to technology shocks than to monetary policy shocks when the former affects profits more than the latter. Furthermore, strategic complementarities in price setting generate complementarities in the optimal allocation of attention. Therefore, each firm has an incentive to acquire more information on the variables that the other firms are, on average, more informed about. These complementarities induce a powerful amplification mechanism of the difference in the speed with which prices respond to technology shocks and to monetary policy shocks.

Suggested Citation

  • Luigi Paciello, 2008. "The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention," EIEF Working Papers Series 0816, Einaudi Institute for Economics and Finance (EIEF), revised Nov 2007.
    • Handle: RePEc:eie:wpaper:0816
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    Cited by:

    1. Paciello, Luigi, 2007. "The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention," MPRA Paper 5763, University Library of Munich, Germany.
    2. Bartosz Maćkowiak & Mirko Wiederholt, 2015. "Business Cycle Dynamics under Rational Inattention," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(4), pages 1502-1532.
    3. Dupor, Bill & Han, Jing & Tsai, Yi-Chan, 2009. "What do technology shocks tell us about the New Keynesian paradigm?," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 560-569, May.
    4. Saint-Paul, Gilles, 2010. "A "quantum" approach to rational inattention," CEPR Discussion Papers 7739, C.E.P.R. Discussion Papers.
    5. Leonardo Melosi, 2009. "A Likelihood Analysis of Models with Information Frictions," 2009 Meeting Papers 1034, Society for Economic Dynamics.
    6. Robert B. Barsky & Eric R. Sims, 2012. "Information, Animal Spirits, and the Meaning of Innovations in Consumer Confidence," American Economic Review, American Economic Association, vol. 102(4), pages 1343-1377, June.
    7. Saint-Paul, Gilles, 2017. "A “quantized” approach to rational inattention," European Economic Review, Elsevier, vol. 100(C), pages 50-71.
    8. Olivier Coibion & Yuriy Gorodnichenko, 2012. "What Can Survey Forecasts Tell Us about Information Rigidities?," Journal of Political Economy, University of Chicago Press, vol. 120(1), pages 116-159.

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