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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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References

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  1. Klenow, Peter J. & Malin, Benjamin A., 2010. "Microeconomic Evidence on Price-Setting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 6, pages 231-284 Elsevier.
  2. Ricardo Reis, 2005. "Inattentive Producers," NBER Working Papers 11820, National Bureau of Economic Research, Inc.
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