Imperfect Information and Hidden Dynamics

In a DSGE rational expectations model, the agents’ assumed information sets are crucial for both the dynamics of the solution and for whether a SVAR econometrician can infer impulse responses to structural shocks. We adopt a heterogeneous agent, incomplete markets general framework where agents have imperfect and idiosyncratic information sets. In the limiting empirically plausible case of extreme heterogeneity, we show that a unique finite state space solution exists taking the same form as a single agent problem. The solution induces higher-order dynamics, hidden both from the agents and the econometrician, that would be absent in a perfect information economy.