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Public and Private Information in Monetary Policy Models

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  • Jeffery D. Amato
  • Hyun Song Shin

Abstract

We examine the impact of public information in an economy where agents also have diverse private information. Our work builds on seminal contributions by Townsend (1983) and Phelps (1983), and more recently Woodford (2002), which emphasized the importance of higher-order beliefs – that is, beliefs about the beliefs of others – in an environment where agents’ interests are intertwined. Following Woodford, our focus is on the pricing behaviour of monopolistically competitive firms, where the intertwining of interests arises from strategic complementarity in the pricing decisions of firms. In setting prices, firms try to second-guess prices set by their competitors. Our analysis proceeds in two steps. Beginning with a series of simplified examples, we show how differentially informed firms follow pricing rules that suppress their own information, but instead put disproportionately large weight on commonly shared information. For reasonable degrees of strategic complementarity, the aggregate price suffers substantial information loss, and therefore ceases to be an informative signal of the underlying demand and cost conditions. We follow this up by developing a general equilibrium model incorporating households and the central bank. We find that the disproportionate role of public information degrades the informational value of economic outcomes for firms and the policymaker alike, alters the welfare consequences of increased precision of public information and generates distinctive time series characteristics of some macro variables. In part, these results extend a recent finding by Morris and Shin (2002) that increased precision of public information may impair social welfare in a game of second-guessing reminiscent of Keynes's `beauty contest'. Finally, we trace out the welfare implications of different parametrizations of the policy rule, particularly focusing upon the implications of the relative precision of private and public information

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Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 117.

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Date of creation: Jul 2004
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Handle: RePEc:dnb:staffs:117

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  1. Klaus Adam, 2003. "Optimal Monetary Policy with Imperfect Common Knowledge," Computing in Economics and Finance 2003 263, Society for Computational Economics.
  2. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  3. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
  4. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  5. Philippe Bacchetta & Eric Van Wincoop, 2006. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," American Economic Review, American Economic Association, vol. 96(3), pages 552-576, June.
  6. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  7. Bomfim, Antulio N., 2001. "Measurement error in general equilibrium: the aggregate effects of noisy economic indicators," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(3), pages 585-603, December.
  8. Joseph G. Pearlman & Thomas J. Sargent, 2005. "Knowing the Forecasts of Others," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 480-497, April.
  9. Stephen Morris & Franklin Allen & Hyun Song Shin, 2004. "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets," Yale School of Management Working Papers, Yale School of Management ysm346, Yale School of Management.
  10. Kenneth Kasa, 1995. "Signal extraction and the propagation of business cycles," Working Papers in Applied Economic Theory 95-14, Federal Reserve Bank of San Francisco.
  11. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  12. Lars E.O Svensson, 2002. "Monetary policy and real stabilization," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 261-312.
  13. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  14. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  15. Shin, Hyun Song & Williamson, Timothy, 1996. "How Much Common Belief Is Necessary for a Convention?," Games and Economic Behavior, Elsevier, vol. 13(2), pages 252-268, April.
  16. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(3), pages 665-690, April.
  17. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  18. Samet, Dov, 1998. "Iterated Expectations and Common Priors," Games and Economic Behavior, Elsevier, vol. 24(1-2), pages 131-141, July.
  19. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 546-88, August.
  20. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
  21. Christian Hellwig, 2002. "Public Announcements, Adjustment Delays, and the Business Cycle (November 2002)," UCLA Economics Online Papers 208, UCLA Department of Economics.
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