A rational inattention unemployment trap

Abstract

We show that introducing rational inattention into a model with uninsurable unemployment risk can generate multiple steady states, when the model with full information has a unique steady state. The model features persistent, heterogeneous labour market expectations, consistent with survey evidence. In a heterogeneous agent New Keynesian model, rational inattention to the future hiring rate generates three steady states: an unemployment trap with mild deflation and a low (but positive) job hiring rate, a middle steady state with moderate employment and inflation, and an ‘employment trap’ with high employment and inflation. Large mutations in the distribution of household beliefs can shift the economy between steady states.