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Monetary Neutrality under Evolutionary Dominance of Bounded Rationality

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  • Gilberto Tadeu Lima

    ()

  • Jaylson Jair da Silveira

    ()

Abstract

We provide evolutionary game-theoretic microfoundations to a dynamic complete nominal adjustment in response to a monetary shock. To this end, we develop an approach based on a new analytical notion to which we refer as boundedly rational inattentiveness. We investigate the behavior of the price level in an context in which a firm can either pay a cost to update its information set and establish the optimal price (Nash strategy) or freely use information from the previous period and establish a lagged optimal price (bounded rationality strategy). We devise an evolutionary micro-dynamics that, by interacting to the dynamics of the aggregate variables, determines the co-evolution of the distribution of information-updating strategies in the population of firms and the extent of the nominal adjustment of the general price level to a monetary shock. Although the bounded rationality strategy is the only survivor in the long-run evolutionary equilibrium, money is nonetheless neutral. The evolutionary learning dynamics takes the information-updating process to an equilibrium configuration in which, despite all firms play the bounded rationality strategy, the corresponding price level is the symmetric Nash equilibrium price.

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Bibliographic Info

Paper provided by University of São Paulo (FEA-USP) in its series Working Papers, Department of Economics with number 2013_03.

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Date of creation: 20 Feb 2013
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Handle: RePEc:spa:wpaper:2013wpecon3

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Keywords: bounded rationality; evolutionary dynamics; monetary neutrality;

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  1. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," NBER Working Papers 8290, National Bureau of Economic Research, Inc.
  2. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
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  15. Peter J. Klenow & Benjamin A. Malin, 2010. "Microeconomic Evidence on Price-Setting," NBER Working Papers 15826, National Bureau of Economic Research, Inc.
  16. Sethi, Rajiv & Franke, Reiner, 1995. "Behavioural Heterogeneity under Evolutionary Pressure: Macroeconomic Implications of Costly Optimisation," Economic Journal, Royal Economic Society, vol. 105(430), pages 583-600, May.
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