Working Paper: NBER ID: w20817
Authors: Fernando Alvarez; Francesco Lippi; Luigi Paciello
Abstract: We study models where prices respond slowly to shocks because firms are rationally inattentive. Producers must pay a cost to observe the determinants of the current profit maximizing price, and hence observe them infrequently. To generate large real effects of monetary shocks in such a model the time between observations must be long and/or highly volatile. Previous work on rational inattentiveness has allowed for observation intervals which are either constant-but-long (e.g. Caballero (1989) or Reis (2006)) or volatile-but-short (e.g. Reis’s (2006) example where observation costs are negligible), but not both. In these models, the real effects of monetary policy are small for realistic values of the average time between observations. We show that non- negligible observation costs produce both these effects: intervals between observations are both infrequent and volatile. This generates large real effects of monetary policy for realistic values of the average time between observations.
Keywords: monetary shocks; rational inattention; observation costs
JEL Codes: E12; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| observation costs (C90) | frequency of observations (C29) |
| frequency of observations (C29) | real effects of monetary shocks (E39) |
| persistence of observation costs (C41) | variability of observation times (C41) |
| variability of observation times (C41) | real effects of monetary shocks (E39) |