IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/7691.html
   My bibliography  Save this paper

Business Cycle Dynamics under Rational Inattention

Author

Listed:
  • Mackowiak, Bartosz Adam
  • Wiederholt, Mirko

Abstract

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.

Suggested Citation

  • Mackowiak, Bartosz Adam & Wiederholt, Mirko, 2010. "Business Cycle Dynamics under Rational Inattention," CEPR Discussion Papers 7691, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7691
    as

    Download full text from publisher

    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7691
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, Oxford University Press, vol. 123(3), pages 863-904.
    2. Bartosz Maćkowiak & Mirko Wiederholt, 2015. "Business Cycle Dynamics under Rational Inattention," Review of Economic Studies, Oxford University Press, vol. 82(4), pages 1502-1532.
    3. Filip Matějka, 2016. "Rationally Inattentive Seller: Sales and Discrete Pricing," Review of Economic Studies, Oxford University Press, vol. 83(3), pages 1125-1155.
    4. Jean Boivin & Marc P. Giannoni & Ilian Mihov, 2009. "Sticky Prices and Monetary Policy: Evidence from Disaggregated US Data," American Economic Review, American Economic Association, vol. 99(1), pages 350-384, March.
    5. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    6. Bartosz Mackowiak & Mirko Wiederholt, 2019. "Optimal Sticky Prices Under Rational Inattention," Credit and Capital Markets, Credit and Capital Markets, vol. 52(4), pages 573-617.
    7. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2011. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 225-247, April.
    8. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148, Elsevier.
    9. Woodford, Michael, 2009. "Information-constrained state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 56(S), pages 100-124.
    10. 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.
    11. Christopher D. Carroll & Jiri Slacalek & Martin Sommer, 2011. "International Evidence on Sticky Consumption Growth," The Review of Economics and Statistics, MIT Press, vol. 93(4), pages 1135-1145, November.
    12. Christian Hellwig & Laura Veldkamp, 2009. "Knowing What Others Know: Coordination Motives in Information Acquisition," Review of Economic Studies, Oxford University Press, vol. 76(1), pages 223-251.
    13. Alejandro Justiniano & Giorgio E. Primiceri, 2008. "The Time-Varying Volatility of Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 98(3), pages 604-641, June.
    14. Laurence Ball & David Romer, 1990. "Real Rigidities and the Non-Neutrality of Money," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 183-203.
    15. Stijn Van Nieuwerburgh & Laura Veldkamp, 2009. "Information Immobility and the Home Bias Puzzle," Journal of Finance, American Finance Association, vol. 64(3), pages 1187-1215, June.
    16. Stijn Van Nieuwerburgh & Laura Veldkamp, 2010. "Information Acquisition and Under-Diversification," Review of Economic Studies, Oxford University Press, vol. 77(2), pages 779-805.
    17. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    18. Mondria, Jordi, 2010. "Portfolio choice, attention allocation, and price comovement," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1837-1864, September.
    19. Hellwig, Christian & Venkateswaran, Venky, 2009. "Setting the right prices for the wrong reasons," Journal of Monetary Economics, Elsevier, vol. 56(S), pages 57-77.
    20. Paciello, Luigi, 2007. "The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention," MPRA Paper 5763, University Library of Munich, Germany.
    21. Antonella Tutino, 2013. "Rationally inattentive consumption choices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(3), pages 421-439, July.
    22. Laura L. Veldkamp, 2011. "Information Choice in Macroeconomics and Finance," Economics Books, Princeton University Press, edition 1, number 9621.
    23. Fatih Guvenen, 2009. "A Parsimonious Macroeconomic Model for Asset Pricing," Econometrica, Econometric Society, vol. 77(6), pages 1711-1750, November.
    24. Mark Bils & Peter J. Klenow & Benjamin A. Malin, 2012. "Reset Price Inflation and the Impact of Monetary Policy Shocks," American Economic Review, American Economic Association, vol. 102(6), pages 2798-2825, October.
    25. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    26. J. B. Taylor & M. Woodford (ed.), 1999. "Handbook of Macroeconomics," Handbook of Macroeconomics, Elsevier, edition 1, volume 1, number 1, December.
    27. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
    28. Maćkowiak, Bartosz & Moench, Emanuel & Wiederholt, Mirko, 2009. "Sectoral price data and models of price setting," Journal of Monetary Economics, Elsevier, vol. 56(S), pages 78-99.
    29. Virgiliu Midrigan, 2011. "Menu Costs, Multiproduct Firms, and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(4), pages 1139-1180, July.
    30. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1415-1464.
    31. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
    32. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    33. 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.
    34. 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.
    35. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
    36. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    37. 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.).
    38. Paciello, Luigi, 2009. "Monetary Policy Activism and Price Responsiveness to Aggregate Shocks under Rational Inattention," MPRA Paper 16407, University Library of Munich, Germany.
    39. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    40. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2011. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 225-247, April.
    41. Sims, Christopher A., 2010. "Rational Inattention and Monetary Economics," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 4, pages 155-181, Elsevier.
    42. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-2084, December.
    43. Christopher A. Sims, 2006. "Rational Inattention: Beyond the Linear-Quadratic Case," American Economic Review, American Economic Association, vol. 96(2), pages 158-163, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Mackowiak, Bartosz Adam & Matejka, Filip & Wiederholt, Mirko, 2020. "Rational Inattention: A Review," CEPR Discussion Papers 15408, C.E.P.R. Discussion Papers.
    2. Bartosz Mackowiak & Mirko Wiederholt, 2019. "Optimal Sticky Prices Under Rational Inattention," Credit and Capital Markets, Credit and Capital Markets, vol. 52(4), pages 573-617.
    3. Angeletos, G.-M. & Lian, C., 2016. "Incomplete Information in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1065-1240, Elsevier.
    4. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, vol. 99(3), pages 769-803, June.
    5. Bartosz Mackowiak & Frank Smets, 2008. "On implications of micro price data for macro models," Conference Series ; [Proceedings], Federal Reserve Bank of Boston.
    6. Leonardo Melosi, 2017. "Signalling Effects of Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 84(2), pages 853-884.
    7. Luigi Paciello & Mirko Wiederholt, 2014. "Exogenous Information, Endogenous Information, and Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 81(1), pages 356-388.
    8. Paciello, Luigi, 2007. "The Response of Prices to Technology and Monetary Policy Shocks under Rational Inattention," MPRA Paper 5763, University Library of Munich, Germany.
    9. Leonardo Melosi, 2009. "A Likelihood Analysis of Models with Information Frictions," PIER Working Paper Archive 09-009, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    10. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2011. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 225-247, April.
    11. Zorn, Peter, 2016. "Investment under Rational Inattention: Evidence from US Sectoral Data," VfS Annual Conference 2016 (Augsburg): Demographic Change 145572, Verein für Socialpolitik / German Economic Association.
    12. George-Marios Angeletos & Chen Lian, 2016. "Incomplete Information in Macroeconomics: Accommodating Frictions in Coordination," NBER Working Papers 22297, National Bureau of Economic Research, Inc.
    13. Atahan Afsar; José Elías Gallegos; Richard Jaimes; Edgar Silgado Gómez & José Elías Gallegos & Richard Jaimes & Edgar Silgado Gómez, 2020. "Reconciling Empirics and Theory: The Behavioral Hybrid New Keynesian Model," Vniversitas Económica 018560, Universidad Javeriana - Bogotá.
    14. Pasten, Ernesto & Schoenle, Raphael, 2016. "Rational inattention, multi-product firms and the neutrality of money," Journal of Monetary Economics, Elsevier, vol. 80(C), pages 1-16.
    15. George-Marios Angeletos, 2018. "Frictional Coordination," Journal of the European Economic Association, European Economic Association, vol. 16(3), pages 563-603.
    16. Mark Bils & Peter J. Klenow & Benjamin A. Malin, 2012. "Reset Price Inflation and the Impact of Monetary Policy Shocks," American Economic Review, American Economic Association, vol. 102(6), pages 2798-2825, October.
    17. Gbaguidi, David, 2012. "La courbe de Phillips : temps d’arbitrage et/ou arbitrage de temps," L'Actualité Economique, Société Canadienne de Science Economique, vol. 88(1), pages 87-119, mars.
    18. Hassan Afrouzi, 2020. "Strategic Inattention, Inflation Dynamics, and the Non-Neutrality of Money," CESifo Working Paper Series 8218, CESifo.
    19. Etienne Gagnon & David López-Salido & Nicolas Vincent, 2013. "Individual Price Adjustment along the Extensive Margin," NBER Macroeconomics Annual, University of Chicago Press, vol. 27(1), pages 235-281.
    20. Oleksiy Kryvtsov, 2005. "Information Flows and Aggregate Persistence," Computing in Economics and Finance 2005 416, Society for Computational Economics.

    More about this item

    Keywords

    Business Cycles; Dynamic Stochastic General Equilibrium; Information Choice; Monetary Policy; Rational Inattention;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:7691. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://www.cepr.org .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.