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Incomplete Information, Higher-Order Beliefs and Price Inertia

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  • George-Marios Angeletos
  • Jennifer La'O

Abstract

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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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15003.

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Date of creation: May 2009
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Handle: RePEc:nbr:nberwo:15003

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  1. Jennifer La'O & George-Marios Angeletos, 2009. "Dispersed Information over the Business Cycle: Optimal Fiscal and Monetary Policy," 2009 Meeting Papers 221, Society for Economic Dynamics.
  2. Kristoffer Nimark, 2007. "Dynamic Pricing and Imperfect Common Knowledge," RBA Research Discussion Papers rdp2007-12, Reserve Bank of Australia.
  3. Ricardo Reis, 2006. "Inattentive Producers," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 793-821.
  4. Kristoffer Nimark, 2007. "Dynamic Higher Order Expectations," 2007 Meeting Papers 542, Society for Economic Dynamics.
  5. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  6. Atsushi Kajii & Stephen Morris, . ""The Robustness of Equilibria to Incomplete Information*''," CARESS Working Papres 95-18, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  7. Bartosz Mackowiak & Mirko Wiederholt, 2004. "Optimal Sticky Prices under Rational Inattention," SFB 649 Discussion Papers SFB649DP2005-040, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany, revised Jul 2005.
  8. Jeffery Amato & Hyun Shin, 2006. "Imperfect common knowledge and the information value of prices," Economic Theory, Springer, vol. 27(1), pages 213-241, 01.
  9. Klenow, Peter J. & Willis, Jonathan L., 2007. "Sticky information and sticky prices," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 79-99, September.
  10. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November.
  11. George-Marios Angeletos & Alessandro Pavan, 2007. "Efficient Use of Information and Social Value of Information," Econometrica, Econometric Society, vol. 75(4), pages 1103-1142, 07.
  12. George-Marios Angeletos & Jennifer La'O, 2009. "Noisy Business Cycles," NBER Working Papers 14982, National Bureau of Economic Research, Inc.
    • George-Marios Angeletos & Jennifer La'O, 2010. "Noisy Business Cycles," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 319-378 National Bureau of Economic Research, Inc.
  13. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  14. Mackowiak, Bartosz Adam & Wiederholt, Mirko, 2010. "Business Cycle Dynamics under Rational Inattention," CEPR Discussion Papers 7691, C.E.P.R. Discussion Papers.
  15. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-44, December.
  16. Barton L. Lipman, 2003. "Finite Order Implications of Common Priors," Econometrica, Econometric Society, vol. 71(4), pages 1255-1267, 07.
  17. George-Marios Angeletos & Alessandro Pavan, 2007. "Policy with Dispersed Information," NBER Working Papers 13590, National Bureau of Economic Research, Inc.
  18. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-84, December.
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  20. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
  21. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
  22. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  23. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
  24. Stephen Morris & Hyun Song Shin, 2006. "Inertia of Forward-Looking Expectations," American Economic Review, American Economic Association, vol. 96(2), pages 152-157, May.
  25. Michael Woodford, 2008. "Information-Constrained State-Dependent Pricing," NBER Working Papers 14620, National Bureau of Economic Research, Inc.
  26. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  27. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2007. "Wall Street and Silicon Valley: A Delicate Interaction," NBER Working Papers 13475, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Fernando Alvarez & Francesco Lippi & Luigi Paciello, 2010. "Optimal Price Setting with Observation and Menu Costs," EIEF Working Papers Series 1010, Einaudi Institute for Economics and Finance (EIEF), revised May 2010.
  2. Amberger, Korie, 2013. "The Role of Capital on Noise Shocks," MPRA Paper 46483, University Library of Munich, Germany.
  3. Marta Areosa & Waldyr Areosa & Vinicius Carrasco, 2012. "A Sticky-Dispersed Information Phillips Curve: a model with partial and delayed information," Working Papers Series 276, Central Bank of Brazil, Research Department.
  4. Nimark, Kristoffer P, 2013. "Man-bites-dog Business Cycles," CEPR Discussion Papers 9517, C.E.P.R. Discussion Papers.
  5. Leonardo Melosi, 2013. "Signaling Effects of Monetary Policy," PIER Working Paper Archive 13-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  6. Leonardo Melosi, 2011. "Public's Inflation Expectations and Monetary Policy," 2011 Meeting Papers 1151, Society for Economic Dynamics.
  7. Manoj Atolia & Ryan Chahrour, 2013. "Intersectoral Linkages, Diverse Information, and Aggregate Dynamics in a Neoclassical Model," Boston College Working Papers in Economics 832, Boston College Department of Economics.

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