Monetary policy, endogenous inattention, and the volatility trade-off

Branch, William A.; Carlson, John B.; Evans, George W.; McGough, Bruce

doi:10.26509/frbc-wp-200411

Working Paper

Monetary policy, endogenous inattention, and the volatility trade-off

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 1980s.

Keywords: Monetary policy; Inflation (Finance);

https://doi.org/10.26509/frbc-wp-200411