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Incomplete Information and Informative Pricing: Theory and Application

  • University of California

    (San Diego)

  • Giacomo Rondina

This paper studies the information contained in the equilibrium aggregate price level of an economy where firms make output price decisions faced with incomplete information about economy-wide disturbances. It is shown that when heterogeneously informed firms are allowed to extract information from the equilibrium aggregate price, the ability of the aggregate price to be a sufficient statistics of the underlying aggregate disturbance depends on the degree of strategic complementarity in firms' pricing strategy. As the incentive to price similarly increases, aggregate price goes from a perfect to an imperfect signal of changes in the aggregate state of the economy. More generally, this paper contributes to the expanding literature on monetary business cycle and incomplete information initiated by Woodford (2003a) in three directions. First, it proposes a set of techniques in the frequency domain that allow for the explicit derivation of individual heterogeneous expectations in a log-linear framework while preserving the tractability of the equilibrium fixed point condition. Second, it develops and solves a stylized model where aggregate price plays a key informational role for imperfectly informed firms of the type advocated by Hayek. Finally, it presents an application to monetary policy in a setting with a simple feedback rule for the supply of money.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 981.

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Date of creation: 2008
Date of revision:
Handle: RePEc:red:sed008:981
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Kenneth Kasa, 1995. "Signal extraction and the propagation of business cycles," Working Papers in Applied Economic Theory 95-14, Federal Reserve Bank of San Francisco.
  2. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 247-79, April.
  3. Gabriele Galati & William R. Melick, 2006. "The evolving inflation process: an overview," BIS Working Papers 196, Bank for International Settlements.
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