Inattention to Rare Events

42 Pages Posted: 1 Nov 2011

See all articles by Bartosz Maćkowiak

Bartosz Maćkowiak

European Central Bank (ECB)

Mirko Wiederholt

Northwestern University - Department of Economics

Date Written: October 2011

Abstract

Why were people so unprepared for the global financial crisis, the European debt crisis, and the Fukushima nuclear accident? To address this question, we study a model in which agents make state-contingent plans - think about actions in different contingencies - subject to the constraint that agents can process only a limited amount of information. The model predicts that agents are unprepared in a state when the state has a low probability, the optimal action in that state is uncorrelated with the optimal action in normal times, and actions are strategic complements. We then compare the equilibrium allocation of attention to the efficient allocation of attention. We characterize analytically the conditions under which society would be better off if agents thought more carefully about optimal actions in rare events.

Keywords: disasters, efficiency, rare events, rational inattention

JEL Classification: D83, E58, E60

Suggested Citation

Maćkowiak, Bartosz and Wiederholt, Mirko, Inattention to Rare Events (October 2011). CEPR Discussion Paper No. DP8626. Available at SSRN: https://ssrn.com/abstract=1952487

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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