Nominal Rigidities, Rational Inattention, and the Optimal Price Index Stabilization Policy

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

Suggested Citation: Suggested Citation

Ou, Shengliang and Yin, Penghui and Zhang, Donghai and Zhang, Renbin, Nominal Rigidities, Rational Inattention, and the Optimal Price Index Stabilization Policy (July 28, 2023). Available at SSRN: https://ssrn.com/abstract=4524244 or http://dx.doi.org/10.2139/ssrn.4524244