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Monetary Policy, Endogenous Inattention, and the Volatility Trade-off

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Author Info

  • Wiliam Branch

    (University of Californis - Irvine)

  • John Carlson

    (Federal Reserve Bank of Cleveland)

  • George W. Evans

    ()
    (University of Oregon Economics Department)

  • Bruce McGough

    (Oregon State University)

Abstract

This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "Great Moderation" that began in the 1980's.

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Bibliographic Info

Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2004-19.

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Length: 52
Date of creation: 07 Dec 2004
Date of revision: 15 May 2007
Handle: RePEc:ore:uoecwp:2004-19

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Keywords: expectations; optimal monetary policy; bounded rationality; economic stability; adaptive learning;

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References

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  3. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
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Citations

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Cited by:
  1. Evans , George W & Honkapohja, Seppo, 2007. "Expectations, learning and monetary policy: an overview of recent research," Research Discussion Papers 32/2007, Bank of Finland.
  2. Alberto Locarno, 2007. "Imperfect Knowledge, Adaptive Learning, and the Bias Against Activist Monetary Policies," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 47-85, September.
  3. George W. Evans & William A. Branch, 2005. "Model Uncertainty and Endogenous Volatility," Computing in Economics and Finance 2005 33, Society for Computational Economics.
  4. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky information versus sticky prices: a proposal to replace the New-Keynesian Phillips curve," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  5. Pfajfar, D., 2012. "Formation of Rationally Heterogeneous Expectations," Discussion Paper 2012-083, Tilburg University, Center for Economic Research.
  6. Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.
  7. William A. Branch & John B. Carlson & George W. Evans & Bruce McGough, 2006. "Adaptive learning, endogenous inattention, and changes in monetary policy," Working Paper 0610, Federal Reserve Bank of Cleveland.
  8. Ricardo Reis, 2009. "Optimal Monetary Policy Rules in an Estimated Sticky-Information Model," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(2), pages 1-28, July.
  9. Lena Dräger, 2011. "Endogenous Persistence with Recursive Inattentiveness," Macroeconomics and Finance Series 201103, Hamburg University, Department Wirtschaft und Politik.

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