This paper investigates who incomplete information impacts the response of prices to nominal shocks. Our baseline model is a variant of the Calvo model in which firms observe the underlying nominal shocks with noise. In this model, the response of prices is pinned down by three parameters: the precision of available information about the nominal shock; the frequency of price adjustment; and the degree of strategic complementarity in pricing decisions. This result synthesizes the broader lessons of the pertinent literature. We next highlight that his synthesis provides only a partial view of the role or incomplete information. In general, the precision of information does not pin down the response of higher-order beliefs. Therefore, once cannot quantify the degree of price inertia without additional information about the dynamics of higher-order beliefs, or the agents' forecasts of inflation. We highlight the distinct role of higher-order beliefs with three extensions of our baseline model, all of which break the tight connection between the precision of information and higher-order beliefs featured in previous work.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
15003.
Length: Date of creation: May 2009 Date of revision: Handle: RePEc:nbr:nberwo:15003
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Find related papers by JEL classification: D8 - Microeconomics - - Information, Knowledge, and Uncertainty E1 - Macroeconomics and Monetary Economics - - General Aggregative Models E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
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