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Incomplete Information, Higher-Order Beliefs and Price Inertia

  • George-Marios Angeletos
  • Jennifer La'O

This paper investigates who incomplete information impacts the response of prices to nominal shocks. Our baseline model is a variant of the Calvo model in which firms observe the underlying nominal shocks with noise. In this model, the response of prices is pinned down by three parameters: the precision of available information about the nominal shock; the frequency of price adjustment; and the degree of strategic complementarity in pricing decisions. This result synthesizes the broader lessons of the pertinent literature. We next highlight that his synthesis provides only a partial view of the role or incomplete information. In general, the precision of information does not pin down the response of higher-order beliefs. Therefore, once cannot quantify the degree of price inertia without additional information about the dynamics of higher-order beliefs, or the agents' forecasts of inflation. We highlight the distinct role of higher-order beliefs with three extensions of our baseline model, all of which break the tight connection between the precision of information and higher-order beliefs featured in previous work.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15003.

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Date of creation: May 2009
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Publication status: published as Incomplete Information, Higher-Order Beliefs, and Price Inertia [slides] Journal of Monetary Economics 56:S1 (October 2009) (with Jennifer La'O)
Handle: RePEc:nbr:nberwo:15003
Note: EFG ME
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  1. Stephen Morris & Hyun Song Shin, 2006. "Inertia of Forward-Looking Expectations," American Economic Review, American Economic Association, vol. 96(2), pages 152-157, May.
  2. George-Marios Angeletos & Alessandro Pavan, 2008. "Policy with Dispersed Information," Carlo Alberto Notebooks 86, Collegio Carlo Alberto.
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  7. Nimark, Kristoffer, 2008. "Dynamic pricing and imperfect common knowledge," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 365-382, March.
  8. Jennifer La'O & George-Marios Angeletos, 2009. "Dispersed Information over the Business Cycle: Optimal Fiscal and Monetary Policy," 2009 Meeting Papers 221, Society for Economic Dynamics.
  9. George-Marios Angeletos & Jennifer La'O, 2010. "Noisy Business Cycles," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 319-378 National Bureau of Economic Research, Inc.
  10. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky information versus sticky prices: a proposal to replace the New-Keynesian Phillips curve," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  14. Michael Woodford, 2008. "Information-Constrained State-Dependent Pricing," Discussion Papers 0809-12, Columbia University, Department of Economics.
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  18. Kristoffer Nimark, 2007. "Dynamic higher order expectations," Economics Working Papers 1118, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2011.
  19. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
  20. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-84, December.
  21. Peter J. Klenow & Jonathan L. Willis, 2006. "Sticky information and sticky prices," Research Working Paper RWP 06-13, Federal Reserve Bank of Kansas City.
  22. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2007. "Wall Street and Silicon Valley: A Delicate Interaction," NBER Working Papers 13475, National Bureau of Economic Research, Inc.
  23. 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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  25. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  26. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
  27. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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