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Optimal monetary policy with imperfect common knowledge Author info | Abstract | Publisher info | Download info | Related research | Statistics Klaus Adam () (European Central Bank, Postfach 160319, 60311 Frankfurt am Main, Germany. )
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We study optimal nominal demand policy in an economy with monopolistic competition and flexible prices when firms have imperfect common knowledge about the shocks hitting the economy. Information imperfections emerge endogenously because firms are assumed to have finite (Shannon) capacity to process information. We then ask how policy that minimizes a quadratic objective in output and prices depends on firms' processing capacity. When price setting decisions are strategic complements, for a large range of capacity values optimal policy nominally accommodates mark-up shocks in the short-run. This holds even if the policy maker observes shocks imperfectly or is uncertain about firms' capacity parameter. With persistent mark-up shocks accommodation may increase in the medium term, but decreases in the long-run thereby generating a hump-shaped price response and a slow reduction in output. JEL Classification: E31; E52; D82.
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Paper provided by European Central Bank in its series Working Paper Series with number
223.
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Length: 38 pages
Date of creation: Apr 2003Date of revision:
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Keywords: Optimal policy information frictions imperfect common knowledge higher order beliefs Shannon capacity. Other versions of this item:
Article Paper Klaus Adam, 2003.
"Optimal Monetary Policy with Imperfect Common Knowledge ,"
Computing in Economics and Finance 2003
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[Downloadable!] Klaus Adam, 2004.
"Optimal Monetary Policy with Imperfect Common Knowledge ,"
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"Optimal Monetary Policy with Imperfect Common Knowledge ,"
CEPR Discussion Papers
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Laurence Ball & N. Gregory Mankiw & Ricardo Reis, 2003.
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Svensson, Lars E. O. & Woodford, Michael, 2004.
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Lars E.O. Svensson & Michael Woodford, 2001.
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