This paper models how imperfect memory aﬀects the optimal continuity of policies. We examine the choices of a player (individual or ﬁrm) who observes previous actions but cannot remember the rationale for these actions. In a stable environment, the player optimally responds to memory loss with excess inertia, deﬁned as a higher probability of following old policies than would occur under full recall. In a volatile environment, the player can exhibit excess impulsiveness (i.e., be more prone to follow new information signals). The model provides a memory-loss explanation for some documented psychological biases, implies that inertia and organizational routines should be more important in stable environments than in volatile ones, and provides other empirical implications relating memory and environmental variables to the continuity of decisions.
Hirshleifer, David and Welch, Ivo, "An Economic Approach to the Psychology of Change: Amnesia, Inertia, and Impulsiveness" (2001). Cowles Foundation Discussion Papers. 1565.