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

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  • William Branch

    ()
    (Economics University of California, Irvine)

  • John Carlson
  • George W. Evans
  • Bruce McGough

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 Society for Economic Dynamics in its series 2006 Meeting Papers with number 106.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:106

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Keywords: optimal policy; expectations; adaptive learning;

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Citations

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Cited by:
  1. Pfajfar, D., 2012. "Formation of Rationally Heterogeneous Expectations," Discussion Paper 2012-083, Tilburg University, Center for Economic Research.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. George W. Evans & William A. Branch, 2005. "Model Uncertainty and Endogenous Volatility," Computing in Economics and Finance 2005 33, Society for Computational Economics.
  7. 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.
  8. Lena Dräger, 2011. "Endogenous Persistence with Recursive Inattentiveness," KOF Working papers 11-285, KOF Swiss Economic Institute, ETH Zurich.
  9. Milani, Fabio, 2008. "Learning, monetary policy rules, and macroeconomic stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3148-3165, October.

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