Optimal Sticky Prices under Rational Inattention

86 Pages Posted: 23 Feb 2009 Last revised: 25 Feb 2009

See all articles by Bartosz Maćkowiak

Bartosz Maćkowiak

European Central Bank (ECB)

Mirko Wiederholt

Northwestern University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 23, 2009

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.

Keywords: rational inattention, sticky prices, real effects of nominal shocks

JEL Classification: E3, E5, D8

Suggested Citation

Maćkowiak, Bartosz and Wiederholt, Mirko, Optimal Sticky Prices under Rational Inattention (February 23, 2009). ECB Working Paper No. 1009. Available at SSRN: https://ssrn.com/abstract=1333608

Bartosz Maćkowiak (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Mirko Wiederholt

Northwestern University - Department of Economics ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
(847) 491-8227 (Phone)
(847) 491-7001 (Fax)

HOME PAGE: http://faculty.wcas.northwestern.edu/~mwi774/

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