Business Cycle Dynamics Under Rational Inattention

81 Pages Posted: 1 Mar 2010

See all articles by Bartosz Maćkowiak

Bartosz Maćkowiak

European Central Bank (ECB)

Mirko Wiederholt

Northwestern University - Department of Economics

Date Written: February 2010

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.

Keywords: Business Cycles, Dynamic Stochastic General Equilibrium, Information Choice, Monetary Policy, Rational Inattention

JEL Classification: D83, E31, E32, E52

Suggested Citation

Maćkowiak, Bartosz and Wiederholt, Mirko, Business Cycle Dynamics Under Rational Inattention (February 2010). CEPR Discussion Paper No. DP7691. Available at SSRN: https://ssrn.com/abstract=1559647

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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