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Optimal Stabilization Policy When the Private Sector Has Information Processing Constraints

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  • Klaus Adam

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    (University of Frankfurt and CSEF, Università di Salerno)

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    Abstract

    This paper considers a linear-quadratic control problem and determines how optimal policy is affected when the private sector has finite (Shannon) capacity to process information. Such capacity constraints prevent private agents from perfectly observing the state variables and the policy choices. The first result is that the control problem when including these constraints remains to be of a linear-quadratic form, which makes the problem technically tractable. The main difference to a standard problem are the costs associated with the use of the policy instrument, which are now endogenous. Depending on parameters these costs might be either higher or lower and lead to less or more aggressive optimal policies, respectively. If shocks show persistence and are heteroskedastic then the costs of using the policy instrument are non-constant and generate either sluggish or overshooting optimal policy reactions.

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    Bibliographic Info

    Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 81.

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    Date of creation: 01 Apr 2002
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    Handle: RePEc:sef:csefwp:81

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    Related research

    Keywords: optimal policy; Shannon capacity; communication theory; sluggish and overshooting policy; measurement errors;

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