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Optimal Sticky Prices under Rational Inattention Author info | Abstract | Publisher info | Download info | Related research | Statistics Bartosz Mackowiak
Mirko Wiederholt
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In the data, individual prices change frequently and by large amounts. In standard sticky price models, frequent and large price changes imply a fast response of the aggregate price level to nominal shocks. This paper presents a model in which price setting firms optimally decide what to observe, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in the data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment.
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Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number
SFB649DP2005-040.
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Length: 51 pages
Date of creation: Jun 2004Date of revision:
Jul 2005Handle: RePEc:hum:wpaper:sfb649dp2005-040Contact details of provider: Postal: Spandauer Str. 1,10178 Berlin Phone: +49-30-2093-5708 Fax: +49-30-2093-5617 Email: Web page: http://sfb649.wiwi.hu-berlin.de More information through EDIRC
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Keywords: rational inattention sticky prices real effects of nominal shocks Other versions of this item:
Find related papers by JEL classification: E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit D8 - Microeconomics - - Information, Knowledge, and Uncertainty
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