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Working Paper

Monetary Policy, Endogenous Inattention, and the Volatility Trade-off

This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "great moderation" that began in the 1980s.

Suggested Citation

Branch, William, John B. Carlson, George Evans, and Bruce McGough. 2004. “Monetary Policy, Endogenous Inattention, and the Volatility Trade-off .” Federal Reserve Bank of Cleveland, Working Paper No. 04-11.