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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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File URL: http://economics.uoregon.edu/papers/UO-2004-19_Evans_Inattention.pdf
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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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Web page: http://economics.uoregon.edu/
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Related research

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

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References

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  1. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
  2. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, May.
  3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
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Citations

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Cited by:
  1. 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.
  2. George W. Evans & William A. Branch, 2005. "Model Uncertainty and Endogenous Volatility," Computing in Economics and Finance 2005 33, Society for Computational Economics.
  3. Mankiw, N. Gregory & Reis, Ricardo, 2002. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Scholarly Articles 3415324, Harvard University Department of Economics.
  4. Evans, George W & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch," CEPR Discussion Papers 6640, C.E.P.R. Discussion Papers.
  5. Lena Dräger, 2011. "Endogenous Persistence with Recursive Inattentiveness," Macroeconomics and Finance Series 201103, Hamburg University, Department Wirtschaft und Politik.
  6. Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.
  7. Wiliam Branch & John Carlson & George W. Evans & Bruce McGough, 2006. "Adaptive Learning, Endogenous Inattention, and Changes in Monetary Policy," University of Oregon Economics Department Working Papers 2006-6, University of Oregon Economics Department.
  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. Pfajfar, Damjan, 2013. "Formation of rationally heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1434-1452.

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