Disinflations with sticky information

by 1979- Kiefer, Leonard Carl

This dissertation consists of three essays in which I examine the macroeconomic implications of the delayed acquisition and processing of information on the part of private agents. I also investigate how the private agents’information acquisition decision can in‡uence monetary policy trade-o¤s to explain the Great Moderation: the apparent decline in the volatility of in‡ation, output, and other macroeconomic aggregates after 1983. In my …rst chapter, " Optimal Monetary Policy with Disparate Expectations and Endogenous Inattention " , I study optimal monetary policy in a world where rationally inattentive agents have disparate expectations about the current and future state of the economy. Each individual’s observation of the true state of the economy is polluted by idiosyncratic noise, leading to disparate expectations. This noise can be reduced, but only by incurring a cost. In an environment of monopolistic competition with time varying markups, the monetary authority varies the money supply to trade o¤ price instability for output stability. I solve for the representative household welfare maximizing monetary policy response to markup shocks given that agents choose the precision of the information they acquire depending on this policy. When agents have less precise information, the trade-o¤ between price instability and output stability grows more favorable. However, when the monetary authority tries to exploit this trade-o¤ through more active policy, it induces private agents to acquire more ii information. I show that a reduction in markup shock volatility leads the central bank to moderate their response to shocks, simultaneously lowering the volatility of prices and output by leading agents to expend less e¤ort in acquiring information. This result shows that theoretically, the Great Moderation could have been the result of good luck (less volatility of exogenous shocks) enabling good policy (a greater commitment to price stability). The second chapter " Imperfectly Credible Disin‡ations with Sticky Information " I study the e¤ects of a disin‡ationary policy when price setting behavior is characterized by a Sticky Information Phillips Curve, as derived by Mankiw and Reis. Contrary to the results obtained with a standard Phillips Curve derived from sticky prices, a disin‡ation leads to large recession, even in the absence of credibility problems. When the central bank’s credibility becomes an issue, the length and depth of a disin‡ationary recession becomes greater. I study the optimal speed of disin‡ation and …nd that under the Sticky Information Phillips Curve, short rapid disin‡ations are less costly in terms of the welfare of a representative consumer than a gradualist approach. Finally, when credibility is endogenous more aggressive and rapid disin‡ations are more likely to be successful. In the third chapter, " Disin‡ations with Imperfect Common Knowledge about Changing In‡ation Targets " I study how an economy with rationally inattentive agents responds to a shift in monetary policy from a high in‡ation to low in‡ation regime and how this response depends upon the nominal anchor. Speci…cally I compare disin‡ations engineered through price level targeting to disin‡ations engineered through in‡ation targeting. Under price level targeting the monetary authority commits to a particular path for prices, while under in‡ation targeting the monetary iii authority only responds to the rate of change in the price level. Due to costs of information acquiring and processing economic agents are rationally inattentive and only gather imprecise information, modeled as a noisy signal. Rationally inattentive agents are able to track more easily the state of the economy under a price level targeting regime lowering the marginal bene…t of information relative to the marginal bene…t under in‡ation targeting. When agents face a cost of acquiring and processing information, they will chose to acquire less information in a world where the monetary authority engages in price level targeting resulting in lower output costs of disin‡ations. Calibrating the model under in‡ation targeting to the US experience during the Volcker Disin‡ation of the early 1980s I compare the actual output costs of the disin‡ation to the simulated response to a price level targeting regime. Even holding the information acquired by private agents constant, I …nd a modest reduction in the output losses arising from a disin‡ation with price level targeting. When agents vary their information acquisition based on monetary policy, the gains from price level targeting relative to in‡ation targeting are substantially larger. iv To my Parents, Leonard and Vickey Kiefer v