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.
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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