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Rational Inattention and Aggregate Fluctuations

Author

Listed:
  • Luo Yulei

    () (University of Hong Kong)

  • Young Eric R

    () (University of Virginia)

Abstract

This paper introduces the rational inattention hypothesis (RI) -- that agents process information subject to finite channel constraints -- into a stochastic growth model with permanent technology shocks. We find that RI raises consumption volatility relative to output by introducing an endogenous demand shock. Furthermore, it is shown that incorporating RI can provide an additional internal propagation mechanism (measured by the impulse response function and the autocorrelation function of output growth) and generate higher variance of forecastable movements in output. However, we find that RI cannot resolve these puzzles in the RBC literature -- weak internal propagation and low variance of forecastable movements in output, even with what appears to be a very low capacity channel.

Suggested Citation

  • Luo Yulei & Young Eric R, 2009. "Rational Inattention and Aggregate Fluctuations," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-43, April.
  • Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:14
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    References listed on IDEAS

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    1. Jordi Galí & Pau Rabanal, 2005. "Technology Shocks and Aggregate Fluctuations: How Well Does the Real Business Cycle Model Fit Postwar U.S. Data?," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 225-318 National Bureau of Economic Research, Inc.
    2. Antonella Tutino, 2008. "The rigidity of choice: Lifecycle savings with information-processing limits," Finance and Economics Discussion Series 2008-62, Board of Governors of the Federal Reserve System (U.S.).
    3. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-2084, December.
    4. Batchuluun, Altantsetseg & Luo, Yulei & Young, Eric, 2014. "Portfolio Choice with Information-Processing Limits," MPRA Paper 58538, University Library of Munich, Germany.
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    Citations

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    Cited by:

    1. Yulei Luo & Jun Nie & Eric R. Young, 2015. "Slow Information Diffusion And The Inertial Behavior Of Durable Consumption," Journal of the European Economic Association, European Economic Association, vol. 13(5), pages 805-840, October.
    2. Paul Levine & Joseph Pearlman & George Perendia & Bo Yang, 2012. "Endogenous Persistence in an estimated DSGE Model Under Imperfect Information," Economic Journal, Royal Economic Society, vol. 122(565), pages 1287-1312, December.
    3. Dasgupta, Kunal & Mondria, Jordi, 2018. "Inattentive importers," Journal of International Economics, Elsevier, vol. 112(C), pages 150-165.
    4. Matějka, Filip, 2015. "Rigid pricing and rationally inattentive consumer," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 656-678.
    5. Paul Levine, 2012. "Monetary policy in an uncertain world: probability models and the design of robust monetary rules," Indian Growth and Development Review, Emerald Group Publishing, vol. 5(1), pages 70-88, April.
    6. Filip Matêjka & Alisdair McKay, 2015. "Rational Inattention to Discrete Choices: A New Foundation for the Multinomial Logit Model," American Economic Review, American Economic Association, vol. 105(1), pages 272-298, January.
    7. Yulei Luo, 2006. "Rational Inattention, Portfolio Choice, and the Equity Premium," Computing in Economics and Finance 2006 56, Society for Computational Economics.
    8. Yulei Luo, 2008. "Consumption Dynamics under Information Processing Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(2), pages 366-385, April.
    9. Paul Levine & Joseph Pearlman & Bo Yang, 2012. "Imperfect Information, Optimal Monetary Policy and Informational Consistency," School of Economics Discussion Papers 1012, School of Economics, University of Surrey.
    10. Cristiano Cantore & Vasco J. Gabriel & Paul Levine & Joseph Pearlman & Bo Yang, 2013. "The science and art of DSGE modelling: II – model comparisons, model validation, policy analysis and general discussion," Chapters,in: Handbook of Research Methods and Applications in Empirical Macroeconomics, chapter 19, pages 441-463 Edward Elgar Publishing.
    11. Jangho Yang, 2017. "An Entropy-Constrained Model of Induced Technical Change with a Single Innovation Possibility Frontier," Working Papers 1714, New School for Social Research, Department of Economics.
    12. Luigi Paciello, 2012. "Monetary Policy and Price Responsiveness to Aggregate Shocks under Rational Inattention," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1375-1399, October.
    13. Levine, Paul, 2010. "Monetary policy in an uncertain world: Probability models and the design of robust monetary rules," Working Papers 10/72, National Institute of Public Finance and Policy.
    14. Luo, Yulei & Young, Eric R., 2010. "Asset pricing under information-processing constraints," Economics Letters, Elsevier, vol. 107(1), pages 26-29, April.
    15. Martins, Guilherme & Sinigaglia, Daniel, 2009. "Real Business Cycle Dynamics under Rational Inattention," MPRA Paper 14089, University Library of Munich, Germany.
    16. Yulei Luo, 2005. "Consumption Dynamics, Asset Pricing, and Welfare Effects under Information Processing Constraints," 2005 Meeting Papers 345, Society for Economic Dynamics.
    17. Yulei Luo & Eric R. Young, 2010. "Risk-Sensitive Consumption and Savings under Rational Inattention," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 281-325, October.
    18. Luo, Yulei & Young, Eric, 2013. "Rational Inattention in Macroeconomics: A Survey," MPRA Paper 54267, University Library of Munich, Germany.

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