DP16812 Rational Inattention and the Business Cycle Effects of Productivity and News Shocks

Author(s): Bartosz Adam Mackowiak, Mirko Wiederholt
Publication Date: December 2021
Date Revised: May 2022
Keyword(s): Information Choice, news shock, Productivity Shocks, rational inattention, Real business cycle model
JEL(s): D83, E32, E71
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16812

We solve a real business cycle model with rational inattention (an RI-RBC model). In the standard model, news about future productivity fails to cause business cycle comovement. In response to a positive news shock, consumption rises but employment and investment fall. Introducing rational inattention helps produce comovement. Agents choose an optimal signal about the state of the economy. The optimal signal turns out to confound current with expected future productivity. Labor and investment demand rise after a news shock, causing an output expansion. Rational inattention also improves the propagation of a standard productivity shock, by inducing persistence.