Macroeconomic Expectations and Cognitive Noise

Sung, Yeji

doi:10.24148/wp2024-19

Working Paper

Macroeconomic Expectations and Cognitive Noise

Abstract: This paper examines forecast biases through cognitive noise, moving beyond the conventional view that frictions emerge solely from using external data. By extending Sims’s (2003) imperfect attention model to include imperfect memory, I propose a framework where cognitive constraints impact both external and internal information use. This innovation reveals horizon-dependent forecast sensitivity: short-term forecasts adjust sluggishly while long-term forecasts may overreact. I explore the macroeconomic impact of this behavior, showing how long-term expectations, heavily influenced by current economic conditions, heighten inflation volatility. Moreover, structural estimation indicates that neglecting imperfect memory critically underestimates the informational challenges forecasters encounter.

Keywords: information frictions; rational inattention; business cycle fluctuations;

JEL Classification: D84; E32; E71; G41;

https://doi.org/10.24148/wp2024-19