Dynamic Rational Inattention and the Phillips Curve

72 Pages Posted: 26 Jan 2021

See all articles by Hassan Afrouzi

Hassan Afrouzi

Columbia University

Choongryul Yang

Board of Governors of the Federal Reserve System

Date Written: 2021

Abstract

We develop a fast, tractable, and robust method for solving the transition path of dynamic rational inattention problems in linear-quadratic-Gaussian settings. As an application of our general framework, we develop an attention-driven theory of dynamic pricing in which the Phillips curve slope is endogenous to systematic aspects of monetary policy. In our model, when the monetary authority is more committed to stabilizing nominal variables, rationally inattentive firms pay less attention to changes in their input costs, which leads to a flatter Phillips curve and more anchored inflation expectations. This effect, however, is not symmetric. A more dovish monetary policy flattens the Phillips curve in the short-run but generates a steeper Phillips curve in the long-run. In a calibrated version of our general equilibrium model, we find that our mechanism quantifies a 75% decline in the slope of the Phillips curve in the post-Volcker period, relative to the period before it.

JEL Classification: D830, D840, E030, E580

Suggested Citation

Afrouzi, Hassan and Yang, Choongryul, Dynamic Rational Inattention and the Phillips Curve (2021). Available at SSRN: https://ssrn.com/abstract=3770462 or http://dx.doi.org/10.2139/ssrn.3770462

Hassan Afrouzi (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Choongryul Yang

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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