Information Constraints as Micro-foundations for Nominal Rigidity

1
Information Constraints as Micro-foundations for
Nominal Rigidity

• Filip Matejka
• CERGE-EI,
• A joint workplace of Charles University and
  Academy of Sciences of the Czech Republic

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Understanding nominal rigidity is important

• Why arent most prices perfectly flexible?
• Inflation picks up a few months after interest
  rates are cut by a central bank
• Decrease in consumption tax often doesnt
  translate in immediate decrease of prices
• Input cost hikes do not have rapid effects
• Understanding nominal rigidity is important
• Keynes explanation for monetary policy effects
• Prices affect most economic decisions, etc.

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Information Constraints as Micro-foundations for
Nominal Rigidity

• This paper
• Explanation why prices are rigid
• Prices are rigid because people do not pay full
  attention to changes in the economy
• Specific implications, mathematical formalization

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Sluggishness

• Standard models of nominal rigidity
• Predict immediate response of GDP, unempl. to
  nominal shocks
• More general friction needed information (Chris
  Sims) ..Rational Inattention

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Do we really have little info?

• When investing, choosing a vacation destination,
  negotiating a deal, we should know the exchange
  rates
• If we do not pay attention, we can not react to
  changes

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Yes, I think so

• Not even economists pay attention to economic
  variables, at least the young ones dont
• More important variables are followed more
  closely

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Enough Hand-waving Information Theory

• Mathematically, knowledge is described as
  probability distribution
• Processing information narrows the distribution
• Choosing what to learn is how to narrow the
  distribution

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Economics, Behavioral Insights, Mathematics

• Models simulate
• What information is acquired
• What is the response
• Price responses to shocks

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Findings

• Competitive industries respond to others prices
  rather than input costs, taxes, etc.
• They can lose a lot by being more expensive
• Volatile and competitive industries respond
  faster
• they always need to pay more attention
• Firms respond faster in unusual times
• Hyperinflation, crisis, ..
• Central bank becomes less efficient

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Applications

• Central Banks
• What interest rate adjustment path to adopt
• Transparency is good
• Fiscal Policy
• How to stimulate economy the fastest (what
  industries, what forms)
• Simpler tax codes are beneficial (uniform rates,
  etc. )
• Birth bonuses(?) vs. subsidies on baby shoes,
  public transportation, exhibitions, etc.
• Optimal regulation
• No caps on taxi prices

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Other Applications of Rational Inattention

• Sudden changes of behavior, with Chris Sims
• Portfolio reallocation
• Optimal number of offered varieties, with
  Alisdair McKay
• How many different types of jam to offer
• How many pension plans
• How much discretion to provide subordinates with
• Hayeks informational efficiency of markets

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Thank you.

• ...for rational (in)attention