Attention Cycles
May 7, 2024 Karthik Sastry

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Karthik Sastry is an Assistant Professor of Economics and Public Affairs at Princeton University. He received a PhD in Economics from MIT in 2022 and he was a Prize Fellow in Economics, History, and Politics at Harvard University in the 2022-23 academic year.


Website: https://www.karthiksastry.com/

Paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3592107



Abstract: We study how the extent of bounded rationality evolves with the state of the economy. We introduce a business-cycle model in which firms face a cognitive cost of making precise decisions and decide how much to pay attention to specific states. We analytically characterize equilibrium with non-parametric, statedependent stochastic choice and nonlinear aggregation and dynamics. Firms have greater incentives to direct attention toward states of lower aggregate consumption because they are owned by risk-averse households. This mechanism generates counter-cyclical attention, pro-cyclical mistakes, and an endogenous attention wedge that depresses aggregate productivity when attention is low. We test and validate these macroeconomic predictions and our proposed microeconomic mechanism using novel measures of US public firms input-choice mistakes and a textual proxy for their attention toward macroeconomic conditions. When calibrated to match our measurements, attention cycles generate a significant fraction of the observed stochastic volatility of output growth and shock propagation asymmetries.




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