Imperfect common knowledge and the information value of prices

Summary.

When economic agents have diverse private information on the fundamentals of the economy, prices may serve as a poor aggregator of this private information. We examine the information value of prices in a monopolistic competition setting that has become standard in the New Keynesian macroeconomics literature. We show that public information has a disproportionate effect on agents’ decisions, crowds out private information, and thereby has the potential to degrade the information value of prices. This effect is strongest in an economy with keen price competition. Monetary policy must rely on less informative signals of the underlying cost conditions.

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Correspondence to Jeffery D. Amato.

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Received: 6 November 2003, Revised: 19 November 2004

JEL Classification Numbers:

E31, E32, E58.

This paper supersedes the discussion in the first half of our longer paper that circulated under the title “Public and Private Information in Monetary Policy Models”. We thank Andy Filardo, Marvin Goodfriend, Nobu Kiyotaki, John Moore, Stephen Morris and Lars Svensson for advice and comments at various stages of the project, and to Herakles Polemarchakis, Roko Aliprantis and an anonymous referee for their helpful comments and guidance. The views are those of the authors and do not necessarily represent those of the BIS. The second author acknowledges support from the U.K. ESRC under grant RES 000220450. Correspondence to: H.S. Shin

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Amato, J.D., Shin, H.S. Imperfect common knowledge and the information value of prices. Economic Theory 27, 213–241 (2006). https://doi.org/10.1007/s00199-004-0587-0

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Keywords and Phrases:

  • Differential information
  • Price inertia
  • Common knowledge.