TY  - JOUR
AU  - da Silveira, Rava Azeredo
AU  - Woodford, Michael
TI  - Noisy Memory and Over-Reaction to News
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 25478
PY  - 2019
Y2  - January 2019
DO  - 10.3386/w25478
UR  - http://www.nber.org/papers/w25478
L1  - http://www.nber.org/papers/w25478.pdf
N1  - Author contact info:
Rava Azeredo da Silveira
Département de Physique 
Ecole Normale Supérieure 
24 rue Lhomond 
75005 Paris
France
E-Mail: rava@ens.fr

Michael Woodford
Department of Economics
Columbia University
420 W. 118th Street
New York, NY 10027
Tel: 212/854-1094
Fax: 212-854-8059
E-Mail: mw2230@columbia.edu
AB  - We propose a model of optimal decision making subject to a memory constraint. The constraint is a limit on the complexity of memory measured using Shannon’s mutual information, as in models of rational inattention; but our theory differs from that of Sims (2003) in not assuming costless memory of past cognitive states. We show that the model implies that both forecasts and actions will exhibit idiosyncratic random variation; that beliefs will fluctuate forever around the rational-expectations (perfect-memory) beliefs with a variance that does not fall to zero; and that more recent news will be given disproportionate weight. The model provides a simple explanation for a number of features of expectations in laboratory and field settings, most notably apparent over-reaction of both elicited forecasts and spending decisions to transitory fluctuations in economic time series.
ER  -