Optimal monetary policy with imperfect common knowledge
- We study optimal nominal demand policy in an economy with monopolistic competition and flexible prices when firms have imperfect common knowledge about the shocks hitting the economy. Parametrizing firms´ information imperfections by a (Shannon) capacity parameter that constrains the amount of information flowing to each firm, we study how policy that minimizes a quadratic objective in output and prices depends on this parameter. When price setting decisions of firms are strategic complements, for a large range of capacity values optimal policy nominally accommodates mark-up shocks in the short-run. This finding is robust to the policy maker observing shocks imperfectly or being uncertain about firms´ capacity parameter. With persistent mark-up shocks accommodation may increase in the medium term, but decreases in the long-run thereby generating a hump-shaped price response and a slow reduction in output. Instead, when prices are strategic substitutes, policy tends to react restrictively to mark-up shocks. However, rational expectations equilibria may then not exist with small amounts of imperfect common knowledge.
Author: | Klaus AdamORCiDGND |
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URN: | urn:nbn:de:hebis:30-10189 |
Parent Title (German): | Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 2003,12 |
Series (Serial Number): | CFS working paper series (2003, 12) |
Document Type: | Working Paper |
Language: | English |
Year of Completion: | 2003 |
Year of first Publication: | 2003 |
Publishing Institution: | Universitätsbibliothek Johann Christian Senckenberg |
Release Date: | 2005/06/13 |
Tag: | Shannon capacity; higher order beliefs; imperfect common knowledge; information frictions; optimal policy |
GND Keyword: | Geldpolitik |
HeBIS-PPN: | 20401073X |
Institutes: | Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS) |
Dewey Decimal Classification: | 3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft |
Licence (German): | Deutsches Urheberrecht |