Nominal Rigidities, Rational Inattention, and the Optimal Price Index Stabilization Policy
56 Pages Posted: 1 Aug 2023
Date Written: July 28, 2023
The Optimal Price Index (OPI) stabilization policy traditionally assigns greater importance to stabilize prices in sectors with stickier prices based on multi-sector models with full information or exogenous information frictions. The current paper challenges this prevailing policy prescription by introducing rational inattention. Surprisingly, the OPI attaches a smaller weight to a sector with stickier prices. This counterintuitive result stems from the endogenous relationship between attention and nominal rigidities: firms in sectors with more flexible prices pay less attention to macroeconomic conditions. We provide empirical evidence that supports this mechanism.
Keywords: Sticky Prices, Endogenous Information Acquisition, Price Index Stabiliza- tion, Optimal Policy
JEL Classification: E31, E32, E52, E58
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