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Business cycle dynamics under rational inattention

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  • Maćkowiak, Bartosz
  • Wiederholt, Mirko

Abstract

We develop a dynamic stochastic general equilibrium model with rational inattention by households and firms. Consumption responds slowly to interest rate changes because households decide to pay little attention to the real interest rate. Prices respond quickly to some shocks and slowly to other shocks. The mix of fast and slow responses of prices to shocks matches the pattern found in the empirical literature. Changes in the conduct of monetary policy yield very different outcomes than in models currently used at central banks because systematic changes in policy cause reallocation of attention by decision-makers in households and firms. JEL Classification: D83, E31, E32, E52

Suggested Citation

  • Maćkowiak, Bartosz & Wiederholt, Mirko, 2011. "Business cycle dynamics under rational inattention," Working Paper Series 1331, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20111331
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    References listed on IDEAS

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    More about this item

    Keywords

    business cycles; information choice; monetary policy; rational inattention;

    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

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