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Incomplete Information and Informative Pricing: Theory and Application

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  • University of California

    (San Diego)

  • Giacomo Rondina

Abstract

This paper studies the information contained in the equilibrium aggregate price level of an economy where firms make output price decisions faced with incomplete information about economy-wide disturbances. It is shown that when heterogeneously informed firms are allowed to extract information from the equilibrium aggregate price, the ability of the aggregate price to be a sufficient statistics of the underlying aggregate disturbance depends on the degree of strategic complementarity in firms' pricing strategy. As the incentive to price similarly increases, aggregate price goes from a perfect to an imperfect signal of changes in the aggregate state of the economy. More generally, this paper contributes to the expanding literature on monetary business cycle and incomplete information initiated by Woodford (2003a) in three directions. First, it proposes a set of techniques in the frequency domain that allow for the explicit derivation of individual heterogeneous expectations in a log-linear framework while preserving the tractability of the equilibrium fixed point condition. Second, it develops and solves a stylized model where aggregate price plays a key informational role for imperfectly informed firms of the type advocated by Hayek. Finally, it presents an application to monetary policy in a setting with a simple feedback rule for the supply of money.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 981.

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Date of creation: 2008
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Handle: RePEc:red:sed008:981

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  1. Kenneth Kasa, 2000. "Forecasting the Forecasts of Others in the Frequency Domain," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(4), pages 726-756, October.
  2. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(2), pages 247-79, April.
  3. Gabriele Galati & William R. Melick, 2006. "The evolving inflation process: an overview," BIS Working Papers, Bank for International Settlements 196, Bank for International Settlements.
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Cited by:
  1. Leonardo Melosi, 2012. "Signaling effects of monetary policy," Working Paper Series, Federal Reserve Bank of Chicago WP-2012-05, Federal Reserve Bank of Chicago.
  2. Pengfei Wang & Yi Wen, 2007. "Incomplete information and self-fulfilling prophecies," Working Papers, Federal Reserve Bank of St. Louis 2007-033, Federal Reserve Bank of St. Louis.
  3. Lucia Alessi & Matteo Barigozzi & Marco Capasso, 2007. "A Review of Nonfundamentalness and Identification in Structural VAR Models," LEM Papers Series, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy 2007/22, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  4. Leonardo Melosi, 2009. "A Likelihood Analysis of Models with Information Frictions," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 09-009, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc.
  6. Tille, C├ędric & van Wincoop, Eric, 2014. "Solving DSGE portfolio choice models with dispersed private information," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 40(C), pages 1-24.

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