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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).
