DP5393 Inattentive Producers

Author(s): Ricardo Reis
Publication Date: December 2005
Keyword(s): inattentiveness, inflation, pricing under uncertainty, production, sticky information
JEL(s): D92, E20, E31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5393

I present and solve the problem of a producer who faces costs of acquiring, absorbing, and processing information. I establish a series of theoretical results describing the producer's behaviour. First, I find the conditions under which she prefers to set a plan for the price she charges, or instead prefers to set a plan for the quantity she sells. Second, I show that the agent rationally chooses to be inattentive to news, only sporadically updating her information. I solve for the optimal length of inattentiveness and characterize its determinants. Third, I explicitly aggregate the behaviour of many such producers. I apply these results to a model of inflation. I find that the model can fit the quantitative facts on post-war inflation remarkably well, that it is a good forecaster of future inflation, and that it survives the Lucas critique by fitting also the pre-war facts on inflation moderately well.