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CNB > Economic research > Research publications > CNB Working paper series > 2018 > Sparse Restricted Perception Equilibrium

Sparse Restricted Perception Equilibrium

Volha Audzei, Sergey Slobodyan

In this paper we study model selection under bounded rationality and the impact of monetary policy on the equilibrium choice of forecasting models. We use the concept of sparse rationality (developed recently by Gabaix, 2014), where paying attention to all possible variables is costly and agents can choose to over- or under-emphasize particular variables, even fully excluding some of them. Our main question is whether an initially mis-specified equilibrium (the restricted perceptions equilibrium, or RPE) is compatible with the equilibrium choice of sparse weights describing the allocation of attention to different variables by the agents inhabiting this RPE. In a simple New Keynesian model, we find that the agents stick to their initial mis-specified AR(1) forecasting model choice when monetary policy is less aggressive or inflation is more persistent. We also identify a region in the parameter space where the agents find it advantageous to pay attention to no variable at all.

JEL codes: D84, E31, E37

Keywords: Bounded rationality, expectations, learning, model selection

Issued: September 2018

Download: CNB WP No. 8/2018 (pdf, 1 MB)