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  5. Optimally Imprecise Memory and Biased Forecasts

Optimally Imprecise Memory and Biased Forecasts

  • Rava Azeredo da Silveira
  • Yeji Sung
  • Michael Woodford
American Economic Review (Forthcoming)

Abstract

We propose a model of optimal decision making subject to a memory constraint in the spirit of models of rational inattention; our theory differs from that of Sims (2003) in not assuming costless memory of past cognitive states. The model implies that both forecasts and actions will exhibit idiosyncratic random variation; that average beliefs will exhibit a bias that fluctuates forever; and that more recent news will be given disproportionate weight in forecasts. The model provides a simple explanation for the over-reaction to news observed in the laboratory by Afrouzi et al. (2023).

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