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Dispersed Information over the Business Cycle: Optimal Fiscal and Monetary Policy

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  • Jennifer La'O

    (MIT)

  • George-Marios Angeletos

    (MIT and NBER)

Abstract

We study how the heterogeneity of information impacts the efficiency of the business cycle and the design of optimal fiscal and monetary policy. We do so within a model that features a standard Dixit-Stiglitz demand structure, introduces dispersed private information about the underlying aggregate productivity shock, and allows this information to be imperfectly aggregated through certain prices and macroeconomic indicators. Our key findings are the following: (i) When information is exogenous to the agents' actions, the response of the economy to either fundamentals or noise is efficient along the flexible-price equilibrium. (ii) The endogeneity of learning renders the business cycle inefficient: there is too little learning and too much noise in the business cycle. (iii) Both state-contingent taxes and monetary policy can boost learning over the business cycle. (iv) Typically, this implies that the optimal tax is countercyclical, while the optimal monetary policy is less accommodative than what is consistent with replicating the flexible-price equilibrium. (v) Even if monetary policy were to replicate the flexible-price equilibrium, this would not mean targeting price stability. Rather, the optimal monetary policy has the nominal interest rate increase, and the price level fall, in response to a positive innovation in productivity.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 221.

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Date of creation: 2009
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Handle: RePEc:red:sed009:221

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  1. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 699-713, October.
  2. repec:bla:restud:v:76:y:2009:i:1:p:223-251 is not listed on IDEAS
  3. Manuel Amador & Pierre Olivier Weill, 2008. "Learning from Prices: Public Communication and Welfare," 2008 Meeting Papers 390, Society for Economic Dynamics.
  4. Laura Veldkamp, 2004. "Media Frenzies in Markets for Financial Information," Econometric Society 2004 North American Winter Meetings 4, Econometric Society.
  5. Moscarini, Giuseppe, 2004. "Limited information capacity as a source of inertia," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 2003-2035, September.
  6. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, vol. 99(3), pages 769-803, June.
  7. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  8. Laura Veldkamp & Christian Hellwig, 2006. "Knowing What Others Know: Coordination Motives in Information Acquisition," Working Papers 06-14, New York University, Leonard N. Stern School of Business, Department of Economics.
  9. Ben S. Bernanke & Julio J. Rotemberg, 1997. "NBER Macroeconomics Annual 1997, Volume 12," NBER Books, National Bureau of Economic Research, Inc, number bern97-1.
  10. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  11. Amador, Manuel & Weill, Pierre-Olivier, 2006. "Learning from Private and Public Observation of Other's Actions," MPRA Paper 109, University Library of Munich, Germany.
  12. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
  13. Ben S. Bernanke & Julio J. Rotemberg, 1997. "Editorial in "NBER Macroeconomics Annual 1997, Volume 12"," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 1-6 National Bureau of Economic Research, Inc.
  14. Mirko Wiederholt, 2010. "rational inattention," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
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Cited by:
  1. George-Marios Angeletos & Jennifer La'O, 2009. "Incomplete Information, Higher-Order Beliefs and Price Inertia," NBER Working Papers 15003, National Bureau of Economic Research, Inc.
  2. Paciello, Luigi, 2009. "Monetary Policy Activism and Price Responsiveness to Aggregate Shocks under Rational Inattention," MPRA Paper 16407, University Library of Munich, Germany.

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