Monetary Policy, Endogenous Inattention, and the Volatility Trade-off
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Date
2004-12-07
Authors
Branch, William A.
Carlson, John
Evans, George W., 1949-
McGough, Bruce
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "Great Moderation" that began in the 1980's.
Description
52 p.
Keywords
Expectations, Optimal monetary policy, Bounded rationality, Economic stabilization, Adaptive learning