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Rational Inattention via Ignorance Equivalence
We present a novel approach to finite Rational Inattention (RI) models basedon the ignorance equivalent, a fictitious action with state-dependent payoffsthat effectively summarizes the optimal learning and conditional choices. Theignorance equivalent allows us to recast the RI problem as a standard expectedutility maximization over an augmented choice set called the learning-proofmenu, yielding new insights regarding the behavioral implications of RI, inparticular as new actions are added to the menu. Our geometric approach isalso well suited to numerical methods, outperforming existing ...
Mechanics of Linear Quadratic Gaussian Rational Inattention Tracking Problems
This paper presents a general framework for constructing and solving the multivariate static linear quadratic Gaussian (LQG) rational inattention tracking problem. We interpret the nature of the solution and the implied action of the agent, and we construct representations that formalize how the agent processes data. We apply this infrastructure to the rational inattention price-setting problem, confirming the result that a conditional response to economics shocks is possible, but casting doubt on a common assumption made in the literature. We show that multiple equilibria and a social cost ...
What we don’t know doesn’t hurt us: rational inattention and the permanent income hypothesis in general equilibrium
This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003,2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that,under the assumption of CARA utility with Gaussian shocks, the permanent income hypothesis (PIH) arises in steady state equilibrium due to a balancing of precautionary savings and impatience. We then explore how RI affects the equilibrium joint dynamics of consumption, income and wealth, and find that elastic attention can make the model fit the data better. We finally show that the welfare costs of incomplete ...
Elastic attention, risk sharing, and international comovements
In this paper we examine the effects of elastic information-processing capacity (or optimal inattention) proposed in Sims (2010) on international consumption and income correlations in a tractable small open economy (SOE) model with exogenous income processes. We find that in the presence of capital mobility in financial markets, optimal inattention due to fixed information-processing cost lowers the international consumption correlations by generating heterogeneous consumption adjustments to income shocks across countries facing different macroeconomic uncertainty. In addition, we show that ...