Monetary Shocks in Models with Inattentive Producers

NBER Working Paper No. 20817

Issued in December 2014

NBER Program(s):Economic Fluctuations and Growth, Monetary Economics



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.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w20817

Published: Fernando E. Alvarez & Francesco Lippi & Luigi Paciello, 2016. "Monetary Shocks in Models with Inattentive Producers," The Review of Economic Studies, vol 83(2), pages 421-459. citation courtesy of

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