Wednesday, November 29, 2006

What I'm reading

A reader asks me what research papers I've been reading lately. (Maybe this should be a regular blog feature.) This week I've been studying Optimal Sticky Prices under Rational Inattention. From the abstract:
This paper presents a model in which price setting firms optimally decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in the data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks.
The aim of this paper is similar to some of my joint work with Ricardo Reis, which emphasized that monetary nonneutrality and plausible business-cycle dynamics can arise from "sticky information" on the part of price setters and other decisionmakers. Compared to our work, the framework in this paper has the benefit that price setters here choose how to allocate their scarce attention, whereas in our model sticky information is exogenous. Moreover, price setters here can choose to pay more attention to some types of information than others, whereas in our model when information is outdated, all of it is equally outdated. These significant benefits, however, come at the cost of substantially increased model complexity.

Anyway, this is how I have been allocating my scarce attention this week.