Optimal sticky prices under rational inattention

Bartosz Maćkowiak and Mirko Wiederholt

No 2005-040, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: In the data, individual prices change frequently and by large amounts. In standard sticky price models, frequent and large price changes imply a fast response of the aggregate price level to nominal shocks. This paper presents a model in which price setting firms optimally decide what to observe, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in the data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms' environment.Key words and phrases: rational inattention ; sticky prices ; real effects of nominal shocks

JEL-codes: D8 E3 E5 (search for similar items in EconPapers)
Date: 2005
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Related works:
Journal Article: Optimal Sticky Prices under Rational Inattention (2009)
Working Paper: Optimal sticky prices under rational inattention (2009)
Working Paper: Optimal Sticky Prices under Rational Inattention (2007)
Working Paper: Optimal Sticky Prices under Rational Inattention (2005)
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