Macroeconomics: Strategic Inattention, Inflation Dynamics and the Non-Neutrality of Money

Abstract:

In countries with low and stable inflation, price setters’ inflation expectations are highly dispersed and disconnected from aggregate inflation. Moreover, this disconnect is stronger for firms with fewer
competitors. This paper poses a new dynamic general equilibrium model of rational inattention with oligopolistic pricing that explains these facts. Under high micro-level strategic complementarities (1) the model implied Phillips curve relates inflation mainly to firms' expectations about their competitors' beliefs and (2) firms with fewer competitors pay more attention to their competitors' beliefs and less attention to aggregates. To provide evidence for this channel, I measure micro-level strategic complementarity for a representative sample of firms in New Zealand and document that the average firm faces a strategic complementarity of 0.8, and that it is decreasing with the firms' number of competitors. An exploratory calibration shows that imperfectly competitive firms' strategic inattention to aggregates significantly propagates monetary non-neutrality: it increases the impact response of output to an expansionary monetary policy shock by 25%. It also decreases the impact response of inflation to such a shock by 47% and increases its half-life by 31%.