17.10.2023: Oliver Pfäuti – The inflation attention threshold and inflation surges

Presenter: Oliver Pfäuti
Affiliation: University of Texas at Austin and University of Bern, Department of Economics.

Paper: The Inflation Attention Threshold and Inflation Surges

Date: October 17, 2023
Time: 12:00 GMT (15:00 Israel Time)

Abstract: At the outbreak of the recent inflation surge, the public’s attention to inflation was low but increased rapidly once inflation started to rise. In this paper, I develop a general equilibrium monetary model where it is optimal for agents to pay little attention to inflation when inflation is low and stable, but in which they increase their attention once inflation exceeds a certain threshold. Using survey inflation expectations, I estimate the attention threshold to be at an inflation rate of 4%, with attention in the high-attention regime being twice as high as in the low-attention regime. When calibrated to match these findings, the model generates inflation and inflation expectation dynamics consistent with the recent inflation surge in the US. The attention threshold induces a state dependency: cost-push shocks become more inflationary in times of loose monetary policy. These state-dependent effects are absent in the model with constant attention or under rational expectations. Following simple Taylor rules triggers frequent and prolonged episodes of heightened attention, thereby increasing the volatility of inflation, and—due to the asymmetry of the attention threshold—also the average level of inflation, which leads to substantial welfare losses.

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