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Business Cycle Dynamics under Rational Inattention

  • Mackowiak, Bartosz Adam
  • Wiederholt, Mirko

This paper develops a dynamic stochastic general equilibrium model with rational inattention. Households and decision-makers in firms have limited attention and decide how to allocate their attention. The paper studies the implications of rational inattention for business cycle dynamics. Impulse responses in the model have several properties of empirical impulse responses. Prices respond slowly to monetary policy shocks, faster to aggregate TFP shocks, and very quickly to disaggregate shocks. Therefore, profit losses due to deviations of the actual price from the profit-maximizing price are an order of magnitude smaller than in the Calvo model that generates the same real effects. Consumption responds slowly to aggregate shocks. For standard parameter values, deviations from the consumption Euler equation are cheap in utility terms, implying that households devote little attention to the consumption-saving decision and react slowly to changes in the real interest rate.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7691.

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Date of creation: Feb 2010
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Handle: RePEc:cpr:ceprdp:7691
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  1. Mark Bils & Pete Klenow & Benjamin Malin, 2009. "Reset Price Inflation and the Impact of Monetary Policy Shocks," Discussion Papers 08-041, Stanford Institute for Economic Policy Research.
  2. Bartosz Mackowiak & Mirko Wiederholt, 2008. "Business Cycle Dynamics under Rational Inattention," 2008 Meeting Papers 1059, Society for Economic Dynamics.
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  13. Yulei Luo, 2005. "Consumption Dynamics under Information Processing Constraints," Macroeconomics 0505011, EconWPA, revised 03 Jun 2005.
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  19. Boivin, Jean & Giannoni, Marc & Mihov, Ilian, 2007. "Sticky Prices and Monetary Policy: Evidence from Disaggregated US Data," CEPR Discussion Papers 6101, C.E.P.R. Discussion Papers.
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  22. David H. Autor & Lawrence F. Katz & Melissa S. Kearney, 2005. "Rising Wage Inequality: The Role of Composition and Prices," NBER Working Papers 11628, National Bureau of Economic Research, Inc.
  23. Mirko Wiederholt & Bartosz Mackowiak, 2005. "Optimal Sticky Prices under Rational Inattention," 2005 Meeting Papers 369, Society for Economic Dynamics.
  24. Mackowiak, Bartosz Adam & Moench, Emanuel & Wiederholt, Mirko, 2009. "Sectoral Price Data and Models of Price Setting," CEPR Discussion Papers 7339, C.E.P.R. Discussion Papers.
  25. Stijn Van Nieuwerburgh & Laura Veldkamp, 2008. "Information Acquisition and Under-Diversification," NBER Working Papers 13904, National Bureau of Economic Research, Inc.
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  27. Mondria, Jordi, 2010. "Portfolio choice, attention allocation, and price comovement," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1837-1864, September.
  28. Midrigan, Virgiliu, 2006. "Menu costs, multi-product firms, and aggregate fluctuations," CFS Working Paper Series 2007/13, Center for Financial Studies (CFS).
  29. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  30. Marcin Kacperczyk & Stijn Van Nieuwerburgh & Laura Veldkamp, 2009. "Rational Attention Allocation Over the Business Cycle," NBER Working Papers 15450, National Bureau of Economic Research, Inc.
  31. Mirko Wiederholt, 2010. "rational inattention," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
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