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Rational inattention, misallocation, and the aggregate economy

Naveen Gondhi

Journal of Monetary Economics, 2023, vol. 136, issue C, 50-75

Abstract: I study the effect of firm managers’ information-processing constraints on production decisions, resource misallocation, and the aggregate economy. Managers have a finite information-processing capacity to reduce uncertainty about firm-specific and economy-wide shocks. The model implies that an increase in aggregate uncertainty leads to reallocation of capacity from learning about firm-specific shocks to learning about aggregate state, leading to higher misallocation of resources and lower output. In contrast, an increase in idiosyncratic uncertainty (through an opposite mechanism) has a non-monotonic effect on aggregate productivity. The model produces new implications regarding the co-movement of inputs and Labor-TFP sensitivity which I confirm empirically.

Keywords: Rational inattention; Learning; Misallocation; Aggregate uncertainty; Idiosyncratic uncertainty (search for similar items in EconPapers)
JEL-codes: D84 G12 G14 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1016/j.jmoneco.2023.01.010

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