Attention Cycles

124 Pages Posted: 14 May 2020 Last revised: 8 Feb 2024

See all articles by Joel P. Flynn

Joel P. Flynn

Yale University

Karthik Sastry

Princeton University - Department of Economics

Date Written: February 7, 2024

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, state-dependent 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.

Keywords: Business Cycles, Attention, Bounded Rationality, Shock Propagation, Volatility

JEL Classification: E32, E44, E71, D83

Suggested Citation

Flynn, Joel P. and Sastry, Karthik, Attention Cycles (February 7, 2024). Available at SSRN: https://ssrn.com/abstract=3592107 or http://dx.doi.org/10.2139/ssrn.3592107

Joel P. Flynn (Contact Author)

Yale University ( email )

493 College St
New Haven, CT CT 06520
United States

Karthik Sastry

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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