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Optimal sticky prices under rational inattention

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  • Maćkowiak, Bartosz
  • Wiederholt, Mirko

Abstract

This paper presents a model in which price setting firms decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in micro data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have strong and persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment. JEL Classification: E3, E5, D8

Suggested Citation

  • Maćkowiak, Bartosz & Wiederholt, Mirko, 2009. "Optimal sticky prices under rational inattention," Working Paper Series 1009, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20091009
    Note: 1026376
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    More about this item

    Keywords

    rational inattention; real effects of nominal shocks; sticky prices;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • 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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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