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Monetary Policy, Endogenous Inattention, and the Volatility Trade-off

  • William Branch

    ()

    (Economics University of California, Irvine)

  • John Carlson
  • George W. Evans
  • Bruce McGough

This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the `Great Moderation' that began in the 1980's

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File URL: http://repec.org/sed2006/up.3959.1138146525.pdf
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 106.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:106
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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