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Rational Inattention, Multi-Product Firms and the Neutrality of Money

  • Ernesto Pastén

I augment the rational inattention model of price-setting (in which firms have a limited capacity to process information) to allow firms to produce multiple goods. My main contribution is to highlight the economies of scale in the use of information that arise in this context, which firms exploit by acquiring information of aggregate variables: Aggregate information is useful for pricing all goods; idiosyncratic information is only useful for pricing goods it is concerned with. The model quantitatively predicts average price changes consistent with the data for the U.S., low costs for firms due to the friction, and comovement of prices inside firms. Importantly, the economies of scale in the use of information cut by four the capacity of the model to deliver money non-neutrality when firms produce two goods instead of one. Money becomes almost neutral when firms produce five goods or more.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 664.

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Date of creation: Feb 2012
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Handle: RePEc:chb:bcchwp:664
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