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Imperfect Information and the Business Cycle

  • Fabrice Collard

    ()

    (School of Economics, University of Adelaide)

  • Harris Dellas

    ()

    (Department of Economics, University of Bern)

  • Frank Smets

    ()

    (European Central Bank
    CEPR
    Ghent University)

Imperfect information has played a prominent role in modern business cycle theory. We assess its importance by estimating the New Keynesian (NK) model under alternative informational assumptions. One version focuses on confusion between temporary and persistent disturbances. Another, on unobserved variation in the inflation target of the central bank. A third on persistent misperceptions of the state of the economy (measurement error). And a fourth assumes perfect information (the standard NK-DSGE version). We find that imperfect information contains considerable explanatory power for business fluctuations. Signal extraction seems to provide a conceptually satisfactory, empirically plausible and quantitatively important business cycle mechanism.

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File URL: http://www.economics.adelaide.edu.au/research/papers/doc/wp2009-15.pdf
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Paper provided by University of Adelaide, School of Economics in its series School of Economics Working Papers with number 2009-15.

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Length: 60 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:adl:wpaper:2009-15
Contact details of provider: Postal: Adelaide SA 5005
Phone: (618) 8303 5540
Web page: http://www.economics.adelaide.edu.au/

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  1. de Walque, G. & Smets, F. & Wouters, R., 2005. "Price setting in General Equilibrium: Alternative Specifications," Computing in Economics and Finance 2005 370, Society for Computational Economics.
  2. Guido Lorenzoni, 2006. "A Theory of Demand Shocks," NBER Working Papers 12477, National Bureau of Economic Research, Inc.
  3. Timothy Cogley & Argia M. Sbordone, 2006. "Trend inflation and inflation persistence in the New Keynesian Phillips curve," Staff Reports 270, Federal Reserve Bank of New York.
  4. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  5. Lippi, Francesco & Neri, Stefano, 2007. "Information variables for monetary policy in an estimated structural model of the euro area," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1256-1270, May.
  6. Fabrice Collard & Harris Dellas, 2010. "Monetary Misperceptions, Output, and Inflation Dynamics," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(2-3), pages 483-502, 03.
  7. Dellas, Harris, 2006. "Monetary Shocks and Inflation Dynamics in the New Keynesian Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 543-551, March.
  8. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
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