covered interest rate arbitrage in the interwar period and the keynes einzig conjecture keynes 1923 conjectured that deviations from covered interest rate parity would not be arbitraged unless a profit of at least a half of one percent on an annualized basis was available and that larger deviations would still be moderately persistent because of less than perfect elasticity of supply of arbitrage funds this two part conjecture was given further emphasis by other writers on this period notably einzig 1937 we apply nonlinear econometric techniques to a previously unexploited weekly data base for the 1920s london and new york markets and find strong support for the conjecture

the pricing of foreign currency options this study examines the assumption that the exchange rate follows a log normal probability distribution and it tests whether different stochastic specifications translate into important differences in implied option prices we investigate a class of processes which includes the log normal probability distribution as a limiting case none of the models performs particularly well the main problem appears to be that the volatility estimates from actual exchange rate data are significantly smaller than those implied by observed option prices la formation du prix des options sur des devises etrangeres cette etude examine le pos tulat que le taux de change suit une courbe de probabilite log normale et verifie si des specifications stochastiques differentes se traduisent en des diff6rences importantes dans les prix des options qui en decoulent les auteurs examinent une famille de processus dont le processus log normal est un cas limite aucun des modeles ne donne des resultats particu lierement bons le probleme principal semble etre que la volatilite des evaluations a partir des donnees sur les taux de change reel est plus faible et de maniere significative que celle des evaluations derivees des prix d options observes

predicting early data revisions to u s gdp and the effects of releases on equity markets the effects of data uncertainty on real time decision making can be reduced by predicting data revisions to u s gdp growth we show that survey forecasts efficiently predict the revision implicit in the second estimate of gdp growth but that forecasting models incorporating monthly economic indicators and daily equity returns provide superior forecasts of the data revision implied by the release of the third estimate we use forecasting models to measure the impact of surprises in gdp announcements on equity markets and to analyze the effects of anticipated future revisions on announcement day returns we show that the publication of better than expected third release gdp figures provides a boost to equity markets and if future upward revisions are expected the effects are enhanced during recessions

a note on interest parity and the supply of arbitrage funds the divergence of the actual forward premium on foreign exchange from that dictated by the principle of interest rate parity can arise from two separately identifiable causes 1 an equilibrium position as indicated by the interest parity principle has not been reached or 2 that the principle itself is not a correctly specified equilibrium condition it is the purpose of this note to offer a revised specification of the interest parity condition and to determine whether this version approximates more closely the actual premium as determined in the market it should be made clear however that this is a partial analysis and does not deal with the impact of other forces for example speculation on the forward premium as a result a complete model of the spot and forward markets for foreign exchange such as stein s 1965 is not attempted here in general the principle of interest parity maintains that in equilibrium

imperfect information and the business cycle imperfect information has played a prominent role in modern business cycle theory this paper assesses its importance by estimating the new keynesian nk model under alternative informational assumptions one version focuses on confusion between temporary and persistent disturbances another on unobserved variation in the inflation target of the central bank a third on persistent mis perceptions of the state of the economy measurement error and a fourth assumes perfect information the standard nk dsge version imperfect information is found to contain considerable explanatory power for business fluctuations signal extraction seems to provide a conceptually satisfactory empirically plausible and quantitatively important business cycle mechanism

information and volatility in an economy of interacting agents with both idiosyncratic and aggregate shocks we examine how the structure of private information in uences aggregate volatility the maximal aggregate volatility is attained in a noise free information structure in which the agents confound idiosyncratic and aggregate shocks and display excess response to the aggregate shocks as in lucas 14 for any given variance of aggregate shocks the upper bound on aggregate volatility is linearly increasing in the variance of the idiosyncratic shocks our results hold in a setting of symmetric agents with linear best responses and normal uncertainty we establish our results by providing a characterization of the set of all joint distributions over actions and states that can arise in equilibrium under any information structure this tractable characterization extending results in bergemann and morris 8 can be used to address a wide variety of questions linking information with the statistical moments of the economy

transparency of information and coordination in economies with investment complementarities how do public and private information affect equilibrium allocations and social welfare in economies with investment complementarities and what is the optimal transparency in the information conveyed for example by economic statistics policy announcements or news in the media we first consider an environment where the complementarities are weak so that the equilibrium is unique no matter the structure of information an increase in the precision of public information may have the perverse effect of increasing aggregate volatility nevertheless as long as there is no value to lotteries welfare unambiguously increases with an increase in either the relative or the absolute precision of public information hence full transparency is optimal this is because more transparency facilitates more effective coordination which is valuable from a social perspective on the other hand when complementarities are strong enough that multiple equilibria are possible more transparency permits the market to coordinate more effectively on either the bad or the good equilibrium in this case constructive ambiguity becomes optimal if there is a high risk that more transparency will lead to coordination failures this abstract was borrowed from another version of this item

can information heterogeneity explain the exchange rate determination puzzle empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables we introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts consistent with the evidence the model implies that a observed fundamentals account for little of exchange rate volatility in the short to medium run b over long horizons the exchange rate is closely related to observed fundamentals c exchange rate changes are a weak predictor of future fundamentals and d the exchange rate is closely related to order flow

a single judge solution to beauty contests we show that the equilibrium policy rule in beauty contest models is equivalent to that of a single agent s forecast of the economic fundamental this forecast is conditional on a modified information process which simply discounts the precision of idiosyncratic shocks by the degree of strategic complementarity the result holds for any linear gaussian signal process static or persistent stationary or nonstationary exogenous or endogenous and also extends to network games theoretically this result provides a sharp characterization of the equilibrium and its properties under dynamic information practically it provides a straightforward method to solve models with complicated information structures

rank dependent probabilities within the framework of expected utility theory with rank dependent probabilities the authors present a hypothesis concerning the shape of the probability transformation function this hypothesis is consistent with the preference reversals phenomenon in particular it is consistent with the finding 1 that the frequency of reversals is higher when the p bet is preferred to the corresponding bet than when the bet is preferred over the corresponding p bet and 2 that the bet is chosen more frequently than the corresponding p bet it is also consistent with aversion to fair symmetric risk and with the simultaneous participation in actuarially unfair lotteries and insurance copyright 1990 by royal economic society

learning from private and public observations of othersʼ actions we study how a continuum of agents learn about disseminated information by observing others actions every period each agent observes a public and private noisy signal centered around the aggregate action taken by the population the public signal represents an endogenous aggregate variable such as a price or a quantity the private signal represents the information gathered through private communication and local interactions we identify conditions such that the average learning curve is s shaped learning is slow initially intensifies rapidly and finally converges slowly to the truth we show that increasing public information always slows down learning in the long run and under some conditions reduces welfare lastly optimal diffusion of information requires that agents strive to be different agents need to be rewarded for choosing actions away from the population average

knowing what others know coordination motives in information acquisition we explore how optimal information choices change the predictions of strategic models when a large number of agents play a game with strategic complementarity information choices exhibit complementarity as well if an agent wants to do what others do they want to know what others know this makes heterogeneous beliefs di cult to sustain and may generate multiple equilibria in models with substitutability agents prefer to difierentiate their information choices we use these theoretical results to examine the role of information choice in recent price setting models and to propose modeling techniques that ensure equilibrium uniqueness

financial innovation the discovery of risk and the u s credit crisis abstract financial innovation and overconfidence about the risk of new financial products were key factors behind the 2008 u s credit crisis we show that a model with a collateral constraint in which learning about the risk of a new financial environment interacts with fisherian amplification produces a boom bust cycle in debt asset prices and consumption early realizations of a high borrowing ability regime turn agents optimistic about the persistence probability of this regime conversely the first realization of a low borrowing ability regime turns agents unduly pessimistic the model predicts large increases in household debt land prices and excess returns during 1998 2006 followed by a collapse

expectation shocks and learning as drivers of the business cycle psychological factors market sentiments and less than fully rational shifts in beliefs are widely believed to play a role in the economy yet they are rarely considered in macroeconomic models this paper evaluates the empirical role of expectational shocks on business cycle fluctuations the paper relaxes the rational expectations assumption to exploit survey data on expectations in the estimation of a new keynesian model which allows for learning by economic agents expectation shocks affect the formation of expectations and capture waves of optimism and pessimism that lead agents to form forecasts that deviate from those implied by their learning model the empirical results uncover a crucial role for these novel expectations shocks as a major driving force of the u s business cycle expectation shocks regarding future real activity are the main source of economic fluctuations accounting for roughly half of business cycle fluctuations

slow information diffusion and the inertial behavior of durable consumption this paper studies the aggregate dynamics of durable and nondurable consumption under slow information diffusion sid due to noisy observations and learning within the permanent income framework we show that sid can significantly improve the model s predictions on the joint behavior of income durable consumption and nondurable consumption at the aggregate level specifically we find that sid can significantly improve the model s predictions for i smoothness in durable and nondurable consumption ii autocorrelation of durable consumption and iii contemporaneous correlation between durable and nondurable consumption furthermore we discuss that incorporating a fixed cost into our sid model does a better job of reproducing the infrequent adjustments of durable consumption at the individual level and the slow adjustments at the aggregate level

man bites dog business cycles the newsworthiness of an event is partly determined by how unusual it is and this paper investigates the business cycle implications of this fact signals that are more likely to be observed after unusual events may increase both uncertainty and disagreement among agents in a simple business cycle model such signals can explain why we observe i occasional large changes in macro economic aggregate variables without a correspondingly large change in underlying fundamentals ii persistent periods of high macroeconomic volatility and iii a positive correlation between absolute changes in macro variables and the cross sectional dispersion of survey expectations

news noise and fluctuations an empirical exploration a common view of the business cycle gives a central role to anticipations consumers and firms continuously receive information about the future which is sometimes news and sometimes just noise based on this information consumers and firms choose spending and because of nominal rigidities spending affects output in the short run if ex post the information turns out to be news the economy adjusts gradually to a new level of activity if it turns out to be just noise the economy returns to its initial state therefore the dynamics of news and noise generate both short run and long run changes in aggregate activity this view appears to capture many of the aspects often ascribed to fluctuations the role of animal spirits in affecting demand spirits coming here from a rational reaction to information about the future the role of demand in affecting output in the short run together with the notion that in the long run output follows a natural path determined by fundamentals in this paper we examine whether this view is consistent with the data we reach three main conclusions the first two methodological the third substantive structural vars typically cannot recover news and noise shocks the reason is straightforward if agents face a signal extraction problem and are unable to separate news from noise then the econometrician faced with either the same data as the agents or a subset of these data cannot do it either while structural estimation methods cannot recover the actual time series for news and noise shocks either they can recover underlying structural parameters and thus the relative role and dynamic effects of news and noise shocks estimation of both a simple model and then of a more elaborate dsge model suggest that agents indeed solve such a signal extraction problem and that noise shocks play an important role in determining short run dynamics recent efforts to estimate business cycle models in which expectations about the future play an important role include christiano et al 2010 and schmitt grohe and uribe 2012 those papers follow the approach of jaimovich and rebelo 2009 and model news as perfectly anticipated productivity changes that will occur at

business cycle dynamics under rational inattention we develop a dynamic stochastic general equilibrium dsge model with rational inattention and compare its predictions to data households and decision makers in firms have limited attention and optimally allocate their attention rational inattention is the only source of slow adjustment the model matches the empirical impulse responses to monetary policy shocks and aggregate technology shocks at the same time profit losses and utility losses from inattention are very small furthermore it matters whether one uses this model or a conventional dsge model for policy analysis

expectations learning and business cycle fluctuations this paper explores an alternative theory based on learning dynamics in the con text of an otherwise standard stochastic growth model we consider an environment in which households and firms have an incomplete model of the macroeconomy knowing only their own objectives constraints and beliefs agents are optimizing have a completely specified belief system but do not know the equilibrium map ping between primitive disturbances the aggregate state of the economy and mar ket clearing prices by extrapolating from historical patterns in observed data they approximate this mapping to forecast variables that are exogenous to their decision problems such as the rental rate of capital and the real wage this belief structure has the property that beliefs affect the true data generating process of the economy which in turn affects belief formation the economy is therefore self referential shifts in beliefs about future returns to labor and capital affect current market clear ing prices which in turn can reinforce beliefs in this environment current prices can become less informative about future economic conditions generating fluctuations in real activity this kind of mechanism driving business cycle fluctuations is found in early writ ings on macroeconomic dynamics for example alfred c pigou 1927 on page 122 writes

productivity growth consumer confidence and the business cycle abstract the objective of this paper is to provide in the context of a dynamic general equilibrium model an answer to the following five questions 1 to what extent does an economy subject to regular variations in labor productivity growth differ from one where labor productivity is constant 2 what is the impact on major macro indicators of a one time change in labor productivity growth 3 what are the business cycle implications of autonomous non falsifiable changes in growth expectations 4 what is the potential of such expectation changes for explaining the volatility of consumption to output ratio 5 can autonomous changes in growth expectations help us understand recent business cycle episodes

forward guidance without common knowledge abstract how does the economy respond to news about future policies or future fundamentals standard practice assumes that agents have common knowledge of such news and face no uncertainty about how others will respond relaxing this assumption attenuates the general equilibrium effects of news and rationalizes a form of myopia at the aggregate level we establish these insights within a class of games which nests but is not limited to the new keynesian model our results help resolve the forward guidance puzzle offer a rationale for the front loading of fiscal stimuli and illustrate more broadly the fragility of predictions that rest on long series of forward looking feedback loops jel d82 d83 d84 e12 e23 e52 e62

the dynamic effects of aggregate demand and supply disturbances we interpret fluctuations in gnp and unemployment as due to two types of disturbances disturbances that have a permanent effect on output and disturbances that do not we interpret the first as supply disturbances the second as demand disturbances demand disturbances have a hump shaped mirror image effect on output and unemployment the effect of supply disturbances on output increases steadily over time peaking after two years and reaching a plateau after five years

a multivariate analysis of forecast disagreement confronting models of disagreement with survey data abstract this paper documents multivariate forecast disagreement among professional forecasters and discusses implications for models of heterogeneous expectation formation disagreement varies over time and is positively correlated with general economic uncertainty the degree to which individual forecasters disagree with the average forecast tends to persist over time models of heterogeneous expectation formation can be modified by introducing heterogeneous signal to noise ratios to match this feature furthermore disagreement about correlations of different macroeconomic variables is high on average in general multivariate forecast data can be used more effectively than it has been to estimate models with heterogeneous expectations and to test the mechanisms used to generate disagreement in these models

the uncertainty multiplier and business cycles abstract i study a business cycle model where agents learn about the fundamentals by accumulating capital during recessions agents invest less and this generates noisier estimates of macroeconomic conditions and an increase in uncertainty the endogenous increase in aggregate uncertainty further reduces economic activity and thus gives rise to a multiplier effect that amplifies aggregate fluctuations to discipline learning dynamics i parametrize the model so that it matches not only standard business cycle moments but also survey data on macroeconomic forecasts i find that the uncertainty multiplier amplifies output standard deviation by 16

information markets and the comovement of asset prices traditional asset pricing models predict that covariance between prices of difierent assets should be lower than what we observe in the data this model generates high covariance within a rational expectations framework by introducing markets for information about asset payofis when information is costly rational investors will not buy information about all assets they will learn about a subset because information production has high flxed costs competitive producers charge more for low demand information than for high demand information a price that declines in quantity makes investors want to purchase a common subset of information if investors price many assets using a common subset of information then a shock to one signal is passed on as a common shock to many asset prices these common shocks to asset prices generate excess covariance the cross sectional and time series properties of asset price covariance are consistent with this explanation

covered interest arbitrage in the 1970 s abstract this paper provides an empirical overview on covered interest arbitrage during the flexible exchange rate regime of the 1970 s it estimates the cost of transactions in foreign exchange and security markets and shows that these costs account for most of the deviations from parity

robustness information processing constraints and the current account in small open economies article i nfo in this paper we examine the effects of two types of induced uncertainty model uncertainty due to robust ness rb and state uncertainty due to finite information processing capacity called rational inattention or ri on consumption and the current account we show that the combination of rb and ri improves the model s predictions for i the contemporaneous correlation between the current account and income and ii the volatility and persistence of the current account in small open emerging and developed economies in addition we show that the two informational frictions improve the model s ability to match the impulse response of consumption to income and the relative volatility of consumption to income growth

punishment schedules for capital flight w hat are appropriate penalties to discourage capital flight economic punishments can serve as effective deterrents for economic crimes but the penalties themselves are often costly to impose and enforce good public policy must take these costs into account in addition to the effectiveness of punishment schemes in order to construct a deterrent to economically motivated behaviour the environment that generates this motivation must be well understood we show that the incentives for capital flight can differ in predictable ways this difference in incentives implies that even though standard risk aversion analyses might suggest the opposite it will often be better to penalise larger transactions in a higher proportion than smaller ones a common definition of capital flight is the growth in the stock of one country s claims on non residents that generates income beyond the control of the domestic authorities see for example dooley 1988 rojas suarez 1990 or razin and sadka 1989 this notion is useful because it distinguishes between portfolio motivations for international capital allocation which are desirable on grounds of economic efficiency and movements of capital which are motivated by a desire to evade tax liabilities the latter type of capital movements imposes costs both in terms of lost government revenues and potential distortions in investment decisions we focus therefore on capital movements which are motivated by the illegal desire to shelter investment income from domestic taxation an understanding of capital flight requires a careful and consistent description of the economic environment that generates the motivations for this phenomenon for the remainder of this paper the following assumptions are maintained in order to match as closely as possible conditions that must hold for capital flight to exist

indicator variables for optimal policy the optimal weights on indicators in models with partial information about the state of the economy and forward looking variables are derived and interpreted both for equilibria under discretion and under commitment an example of optimal monetary policy with a partially observable potential output and a forward looking indicator is examined the optimal response to the optimal estimate of potential output displays certainty equivalence whereas the optimal response to the imperfect observation of output depends on the noise in this observation

why do forecasters disagree lessons from the term structure of cross sectional dispersion abstract key sources of disagreement among economic forecasters are identified by using data on cross sectional dispersion in forecasters long and short run predictions of macroeconomic variables dispersion among forecasters is highest at long horizons where private information is of limited value and lower at short forecast horizons moreover differences in views persist through time such differences in opinion cannot be explained by differences in information sets our results indicate they stem from heterogeneity in priors or models differences in opinion move countercyclically with heterogeneity being strongest during recessions where forecasters appear to place greater weight on their prior beliefs

learning asymmetries in real business cycles when a boom ends the downturn is generally sharp and short when growth resumes the boom is more gradual our explanation rests on learning about productivity when agents believe productivity is high they work invest and produce more more production generates higher precision information when the boom ends precise estimates of the slowdown prompt decisive reactions investment and labor fall sharply when growth resumes low production yields noisy estimates of recovery noise impedes learning slows recovery and makes booms more gradual than downturns a calibrated model generates growth rate asymmetry similar to macroeconomic aggregates fluctuations in agents forecast precision match observed countercyclical errors of forecasters

when can changes in expectations cause business cycle fluctuations in neo classical settings abstract it is often argued that changes in expectation are an important driving force of the business cycle however it is well known that changes in expectations cannot generate positive co movement between consumption investment and employment in the most standard neo classical business cycle models this gives rise to the question of whether changes in expectation can cause business cycle fluctuations in any neo classical setting or whether such a phenomenon is inherently related to market imperfections this paper offers a systematic exploration of this issue our finding is that expectation driven business cycle fluctuations can arise in neo classical models when one allows for a sufficiently rich description of the production technology however such a structure is rarely allowed or explored in macro models in particular we identify a multi sector setting and a setting with a costly distribution system in which expectation driven business cycles can arise

information heterogeneity and market incompleteness information is market consistent if agents only use market prices to infer the underlying states of the economy this paper applies this concept to a stochastic growth model with incomplete markets and heterogeneous agents the economy with market consistent information can never replicate the full information equilibrium and there are substantial differences in impulse responses to aggregate productivity shocks these results are robust to the introduction of a noisy public signal and aggregate financial markets we argue that the principle of market consistent information should be applied to any model with incomplete markets

fiscal policy in an unemployment crisis this paper shows that large scal multipliers arise naturally from equilibrium unemployment dynamics in response to a shock that brings the economy into a liquidity trap an expansion in government spending increases output and causes a fall in the unemployment rate since movements in unemployment are persistent the eects of current spending linger into the future leading to an enduring rise in income as an enduring rise in income boosts private demand even a temporary increase in government spending sets in motion a virtuous employment spending spiral with a large associated multiplier this transmission mechanism contrasts with the conventional view in which scal policy may be ecacious only under a prolonged and committed rise in government spending which engineers a spiral of increasing ination

the effect of gnp announcements on fluctuations of gnp growth abstract this paper is an empirical study of the degree in which perceptions affect the evolution of the economy we study the effects of the announcements that the government makes on gnp growth these announcements are subject to a substantial degree of noise and its accuracy improves with time a revised number is published several years after the first announcement was made public we consider that the final revision is the true value of gnp growth we show that once announcements are taken into account the true value of gnp growth at time t has no predictive power in determining growth at any future time all the predictive power lies in the announcements and not in the true level of growth actually we show that the variable that determines future growth is the unexpected part of the announcements we also show that announcements affect growth via aggregate investment

inflation expectations disagreement and monetary policy survey data on inflation expectations show that i private sector forecasts and central bank forecasts are not fully aligned and ii private sector forecasters disagree about inflation expectations to reconcile these two facts we introduce dispersed information in a new keynesian model where as a result inflation expectations differ between the private sector and the central bank we show that output and inflation responses change markedly when the central bank responds to private sector inflation expectations rather than to their own

indicator variables for optimal policy under asymmetric information the optimal weights on indicators in models with partial information about the state of the economy and forward looking variables are derived and interpreted both for equilibria under discretion and under commitment the private sector is assumed to have more information about the state of the economy than the policymaker certainty equivalence holds for the optimal reaction function in state space form t he coefficients are independent of the degree of uncertainty about the state of the economy however in the case of commitment certainty equivalence does not hold for the reaction function in integrative form the policy instrument cannot be written as a distributed lag of past estimates of past states of the economy instead optimal policy will generally depend on new estimates of past states of the economy and in ways that depend on the information structure furthermore the usual separation principle does not hold since the estimation of the state of the economy is not independent of optimization and is in general quite complex we present a general characterization of optimal filtering and control in settings of this kind and discuss an application of our methods to the problem of the optimal use of real time macroeconomic data in the conduct of monetary policy

living in an imaginary world that looks real abstract in the paper we show using standard approaches general equilibrium modeling and the assumption of complete rationality that the macroeconomic environment is endogenous and is indeterminate specifically it is argued without resorting to sunspot type arguments that microeconomic fundamentals do not suffice to characterize the economy at the macro level in particular we show how perceptions of rational agents of the workings of the economy a shape the environment b affect the environment sufficiently to ensure that rational economic agents find the observed environment consistent with their beliefs even though it is not as a by product we illustrate that endogenous macro uncertainty can arise as an outcome if rational economic agents whose expectations are anchored on endogenous variables expect them to arise finally we show that systematic errors can persist indefinitely under rationality

what can survey forecasts tell us about information rigidities a lot we derive common and conflicting predictions from models in which agents face information constraints and then assess their validity using surveys of consumers firms central bankers and professional forecasters we document that mean forecasts fail to completely adjust on impact to shocks leading to statistically and economically significant deviations from the null of full information the dynamics of forecast errors after shocks are consistent with the predictions of models with information rigidities the conditional responses of forecast errors and disagreement among agents can also be used to differentiate between some of the most prominent models of information rigidities

taxation of asset income in the presence of a world securities market abstract this paper examines a capm model of world security prices in which governments recognize their ability to influence international security prices via their tax treatment of foreign and domestic investors in this model governments have the incentive to set tax rates such that investors tend to specialize in domestic securities and to restrict net capital flows between countries each country does this to increase the utility of domestic residents taking as given the tax policies of other governments but the net outcome is a reduction in world efficiency and likely a reduction in the utility of all investors

optimal monetary policy with imperfect common knowledge we study optimal nominal demand policy in a flexible price economy with monopolistic competition where firms have imperfect common knowledge about the shocks hitting the economy information imperfections emerge endogenously because firms are assumed to have finite shannon capacity to process information we then ask how policy that minimizes a quadratic objective in output and prices depends on firms processing capacity when price setting decisions of firms are strategic complements we find that policy should nominally accommodate white noise mark up shocks for a large range of capacity values this fi nding is robust to the policy maker observing shocks imperfectly or being uncertain about firms processing capacity when mark up shocks are persistent accommodation may even have to increase in the medium term but has to decrease 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 with nominal demand contractions to mark up shocks in addition there might exist discontinuities between common knowledge equilibria and equilibria with small amounts of imperfect common knowledge

firms and aggregate dynamics abstract we investigate the role of permanent and transitory shocks for firms and aggregate dynamics we find that permanent shocks to productivity and permanent shifts in the composition of output explain at least four fifths of firms dynamics however these permanent shocks are almost uncorrelated across firms and are therefore less relevant for aggregate dynamics transitory shocks on the other hand are not very important at the firm level but they account for most of the volatility of aggregate hours and output because they are significantly correlated across firms finally we try to make some progress on the interpretation of the shocks

limited information capacity as a source of inertia abstract we derive optimal time dependent adjustment rules from shannon s 1948 information theory in a continuous time lq prediction problem with a costly rate of information acquisition processing the optimal prediction evolves smoothly but jumps at an optimally chosen frequency when fresh information accrues a more volatile and persistent target raises the information rate required to maintain a sampling frequency this cost effect moderates and may even reverse the benefit effect on the value of information so optimal inertia is unresponsive to and nonmonotonic in the predictability of the environment conventional models with a fixed cost per observation imply no such cost effect so inertia rises quickly in the predictability of the environment

inattentive professional forecasters abstract using the ecb survey of professional forecasters to characterize expectations at the micro level we emphasize two new facts forecasters i fail to systematically update their forecasts and ii disagree even when updating it is moreover found that forecasters have predictable forecast errors these facts are qualitatively supportive of recent models of inattention and suggest a setup where agents imperfectly process information due to both sticky information a la mankiw reis and noisy information a la sims however building and estimating such an expectation model we find that it cannot quantitatively replicate the error and disagreement observed in the data

communication and monetary policy recent trends toward greater central bank independence and the adoption of formal inflation targeting by several countries have served to emphasize the importance of communication policy in this paper we explore some of the economic effects of public information that arise whenever public information serves the dual role of conveying fundamental information as well as serving as a focal point for better coordination more precise public information is a double edged tool while it is very effective in influencing actions through coordination sometimes it can be too effective and coordinate actions away from fundamentals copyright 2002 oxford university press

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

forecasting the forecasts of others implications for asset pricing we develop a dynamic asset pricing model with heterogeneously informed agents unlike previous research we focus on the general case where differential information leads to the problem of forecasting the forecasts of others and to non trivial dynamics of higher order expectations in particular we prove that the model does not admit a finite number of state variables using numerical analysis we compare equilibria characterized by identical fundamentals but different information structure we demonstrate that the distribution of information has substantial impact on equilibrium prices and returns in particular we show that asymmetric information can generate momentum in returns and high trading volume

identification and estimation in non fundamental structural varma models the basic assumption of a structural vector autoregressive moving average svarma model is that it is driven by a white noise whose components are uncorrelated or independent and can be interpreted as economic shocks called structural shocks when the errors are gaussian independence is equivalent to non correlation and these models face two identification issues the first identification problem is static and is due to the fact that there is an infinite number of linear transformations of a given random vector making its components uncorrelated the second identification problem is dynamic and is a consequence of the fact that even if a svarma admits a non invertible moving average ma matrix polynomial it may feature the same second order dynamic properties as a varma process in which the ma matrix polynomials are invertible the fundamental representation the aim of this paper is to explain that these difficulties are mainly due to the gaussian assumption and that both identification challenges are solved in a non gaussian framework if the structural shocks are assumed to be instantaneously and serially independent we develop new parametric and semi parametric estimation methods that accommodate non fundamentalness in the moving average dynamics the functioning and performances of these methods are illustrated by applications conducted on both simulated and real data

on the optimal monetary policy response to noisy indicators abstract we describe a behavior of a central bank when its measures of current inflation and output are subject to measurement errors in a framework of optimizing models with nominal price stickiness in our model a central bank sets the interest rate equal to its current estimate of the so called wicksellian natural rate of interest this is shown to imply that the interest rate responds to the central bank s estimates of both current inflation and output gap as advocated by taylor 1993 it is also shown that the noise contained in the indicators justifies a degree of policy cautiousness a reduced form representation of optimal policy should exhibit interest rate smoothing which is often found in the empirical literature on monetary policy reaction functions

how well does the is lm model fit postwar u s data postwar u s time series for money interest rates prices and gnp are characterized by a multivariate process driven by four exogenous disturbances those disturbances are identified so that they can be interpreted as the four main sources of fluctuations found in the is lm phillips curve model money supply money demand is and aggregate supply shocks the dynamic properties of the estimated model are analyzed and shown to match most of the stylized predictions of the model the estimated decomposition is also used to measure the relative importance of each shock to interpret some macroeconomic episodes and to study sources of permanent shocks to nominal variables

a traditional interpretation of macroeconomic fluctuations under the traditional interpretation of macroeconomic fluctuations aggregate demand shocks move output and prices in the same direction while aggregate supply shocks move output and prices in opposite directions this paper examines the joint behavior of u s output unemployment prices wages and nominal money and asks whether it is consistent with this interpretation the answer is a qualified yes

asset demands without the independence axiom an important application of the theory of choice under uncertainty is to asset markets and an important property in these markets is a preference for portfolio diversification if an investor is an expected utility maximizer then s he is risk averse if and only if s he exhibits a preference for diversification this paper examines the relationship between risk aversion and portfolio diversification when preferences over probability distributions of wealth do not have an expected utility representation

the ricardian equivalence proposition evidence from foreign exchange markets abstract the major argument against running large government budget deficits is that they raise interest rates and crowd out real investment conclusive evidence of a relationship between large budget deficits and high interest rates has not been found two competing explanations are tested by examining the impact of government udget announcements on foreign exchange rates the ricardian equivalence proposition that deficits have no crowding out effects is compared to the conventional open economy hhypothesis that capital mobility transfers these effects to foreign exchange rates the results supports the open economy hypothesis over the ricardian equivalence proposition jel f41

an exploration into pigou s theory of cycles abstract this paper explores a theory of business cycles in which recessions and booms arise due to difficulties encountered by agents in properly forecasting the economy s future needs in terms of capital the idea has a long history in the macroeconomic literature as reflected by the work of pigou industrial fluctuation macmillan london 1926 the contribution of this paper is twofold first we illustrate the type of general equilibrium structure that can give rise to such phenomena second we examine the extent to which such a model can explain the observed pattern of u s recessions frequency depth without relying on technological regress we argue that such a model offer a framework for understanding elements of both the recent u s recession and of the asia downturns of the late 1990s

risk aversion in the theory of expected utility with rank dependent probabilities expected utility with rank dependent probability theory is a model of decision making under risk where the preference relations on the set of probability distributions is represented by the mathematical expectation of a utility function with respect to a transformation of the probability distributions on the set of outcomes this paper defines based on g teaux differentiability measures of risk aversion for such preferences which characterize the relation more risk averse and applies these measures to the analysis of unconditional and conditional portfolio choice problems

the law of one price in the eurocurrency market abstract this paper studies the interest rate parity arbitrage condition in the eurocurrency market in the period 1967 to 1980 the results suggest that this market is relatively efficient with few opportunities for arbitrage profits turbulance associated with external shocks to this market is relatively short lived the evidence indicates that the foreign exchange and eurocurrency markets respond rapidly to monetary shocks

learning and shifts in long run productivity growth abstract an extensive literature has analyzed the macroeconomic effects of shocks to the level of aggregate productivity however there has been little corresponding research on sustained shifts in the growth rate of productivity in this paper we examine the effects of shocks to productivity growth in a dynamic general equilibrium model where agents do not directly observe whether shocks are transitory or persistent we show that an estimated kalman filter model using real time data describes economists long run productivity growth forecasts in the united states extremely well and that filtering has profound implications for the macroeconomic effects of shifts in productivity growth

setting the right prices for the wrong reasons we consider a model of nominal price adjustment with firm specific and aggregate shocks to economic fundamentals and incomplete dispersed information firms update their expectations about fundamentals based on their own cash flows revenues and wages we show that in a model with realistic levels of product level price dispersion the firms inference about aggregate shocks is very gradual yet in the aggregate prices adjust rapidly in response to aggregate nominal shocks when an aggregate shock occurs firms mistakenly attribute it to firm specific shocks but adjust prices nevertheless since the exact nature of the shock matters little for its optimal pricing decision

a theory of demand shocks this paper presents a model of business cycles driven by shocks to consumer expectations regarding aggregate productivity agents are hit by heterogeneous productivity shocks they observe their own productivity and a noisy public signal regarding aggregate productivity the public signal gives rise to noise shocks which have the features of aggregate demand shocks they increase output employment and inflation in the short run and have no effects in the long run numerical examples suggest that the model can generate sizable equilibrium dsge models of the business cycle include a large number of shocks to technol ogy monetary policy preferences etc but typically do not include expectational shocks as independent drivers of short run fluctuations 1 this paper explores the idea of expectation driven cycles looking at a model where technology determines equilibrium output in the long run and consumers receive noisy signals about technology in the short run the presence of noisy signals produces expectational errors this paper studies the role of these expectational errors in gener ating volatility at business cycle frequencies the model is based on two ingredients first consumers take time to recognize permanent changes in aggregate fundamentals although they may have good information on the current state of the individual firm or sector where they operate they have only limited information regarding the long run determinants of aggregate activity second consumers have access to public information that is relevant to estimate long run productivity this includes news about technological innovations publicly released macroeconomic and sectoral statistics financial market prices and public statements by policy makers however these signals provide only a noisy forecast of the long run effects of technological innovations this opens the door to noise shocks which induce consumers to temporarily overestimate or underestimate the productive capacity of the economy

beauty contests and iterated expectations in asset markets in a financial market where traders are risk averse and short lived and prices are noisy asset prices today depend on the average expectation today of tomorrow s price thus iterating this relationship the date 1 price equals the date 1 average expectation of the date 2 average expectation of the date 3 price this will not in general equal the date 1 average expectation of the date 3 price we show how this failure of the law of iterated expectations for average belief can help understand the role of higher order beliefs in a fully rational asset pricing model and explain over reaction to noisy public information

noisy fiscal policy abstract this paper investigates the macroeconomic effects of fiscal policy in a setting in which private agents receive noisy signals about future shocks to government expenditures we show how to empirically identify the relative weight of news and noise shocks to government spending and compute the level of noise for canada the uk and the us we then investigate the quantitative implications of imperfect fiscal policy information using a medium scale dsge model we find that when the government seeks to implement a persistent change in expected public spending the existence of noise as estimated using actual data implies a sizable difference in fiscal multipliers compared to the perfect fiscal foresight case

dynamic pricing and imperfect common knowledge abstract introducing private information into the dynamic pricing decision of firms by adding an idiosyncratic component to marginal cost can help explain two stylised facts about price changes aggregate inflation responds gradually and with inertia to shocks at the same time as individual price changes can be large the inertial behaviour of inflation is driven by privately informed firms strategically herding on the public information contained in the observations of lagged aggregate variables the model also matches the average duration between price changes found in the data and it nests the standard new keynesian phillips curve as a special case to solve the model the paper derives an algorithm for solving a class of dynamic models with higher order expectations

information animal spirits and the meaning of innovations in consumer confidence we show that unexplained innovations in several variables representing survey responses to forwardlooking questions on the michigan survey of consumers have powerful prognostic implications for the future paths of macroeconomic variables we attempt to distinguish the hypothesis that these impulse responses indicate a causal channel from autonomous movements in sentiment to economic outcomes the animal spirits view from the alternative interpretation that the surprise confidence movements summarize information about future economic prospects the information view in natural rate models animal spirits shocks are associated with overshooting of among other variables consumption that attenuates when agents come to grips with their overreaction while information shocks about the long future are followed by gradual movements in macroeconomic variables that are not subsequently reversed in a baseline vector autoregression involving consumption income and confidence the data come down sharply in favor of the information view the impulse responses of consumption and gdp show no tendency to attenuate even after a number of years further confidence innovations have strong implications for labor productivity many quarters into the future in somewhat larger vars with an information block that includes inflation and or stock prices the impulse responses to confidence innovations continue to have the permanent shape that defines information shocks but they are smaller in magnitude we demonstrate that this is due to the fact that both inflation and stock price innovations have prognostic implications for future productivity that are very similar to the implications of innovations in confidence addition of unemployment to the system induces a transitory component that changes the shape of the impulse responses and somewhat weakens the previously airtight case against animal spirits but it does not provide constructive evidence of such effects

a reconsideration of the uncovered interest parity relationship abstract this paper argues that the uncovered interest parity uip relationship is distinct from and more important than the unbiasedness of forward exchange rates as predictors of future spot rates the standard finding that the slope estimate b is roughly 3 in regressions of s t on t 1 s t 1 implies rejection of unbiasedness but not necessarily uip the hypothesis that monetary authorities manage interest rates so as to smooth their movements while also resisting changes in exchange rates is attractive conceptually and is capable of explaining not only the b 3 finding but also several other notable features of the data

the macroeconomic effects of false announcements suppose that the government were to announce the economy will be booming in six months and this announcement is based on false data what effect would such an announcement have on future aggregate activity this paper employs revisions of the series of leading economic indicators to test the hypothesis that such an announcement would have a positive effect on future activity we find that the evidence is generally consistent with the hypothesis and that for the time period 1976 1988 the expectational shocks measured by these revisions explain over 20 percent of the fluctuation in the quarterly growth rate of industrial production

interest rate parity tests switzerland and some major western countries abstract this article reviews briefly the interest rate parity ip theory and possible divergences between covered interest rates on two assets denominated in different currencies from direct ip tests involving pairs of assets denominated in sfr and dm using monthly data on 3 month treasury bills and on 3 month euro deposits it appears that the theory holds better for euro currency pairs of assets than for domestic pairs further investigation uncovers significant occurence of autocorrelation for domestic pairs possibly indicating left out explanatory factors in the standard ip formulation and points to the non normality of the distrbution of arbitrage margins thus casting doubts on most statistical results in such tests

are japanese interest rates too stable abstract we examine the effects of japanese financial market liberalization using daily data on eurocurrency and two japanese onshore interest rates the gensaki and cd rates our evidence suggests that japanese money markets are now fully integrated with world markets but that the degree of integration depends heavily on the japanese asset examined in particular we find that the gensaki market is not completely integrated with the euroyen market the cd rate however is cointegrated with the euroyen rate since june 1984 and the euroyen cd rate variance ratio is similar to that of dollar denominated assets after november 1988 jel e43

optimal sticky prices under rational inattention this paper presents a model in which price setting firms decide what to pay attention to subject to a constraint on information flow when idiosyncratic conditions are more variable or more important than aggregate conditions firms pay more attention to idiosyncratic conditions than to aggregate conditions when we calibrate the model to match the large average absolute size of price changes observed in micro data prices react fast and by large amounts to idiosyncratic shocks but only slowly and by small amounts to nominal shocks nominal shocks have strong and persistent real effects we use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms environment jel e 3 e5 d8

implications of rational inattention abstract a constraint that actions can depend on observations only through a communication channel with finite shannon capacity is shown to be able to play a role very similar to that of a signal extraction problem or an adjustment cost in standard control problems the resulting theory looks enough like familiar dynamic rational expectations theories to suggest that it might be useful and practical while the implications for policy are different enough to be interesting

optimal monetary policy with uncertain fundamentals and dispersed information this paper studies optimal monetary policy in a model where aggregate fluctuations are driven by the private sector s uncertainty about the economy s fundamentals information on aggregate productivity is dispersed across agents and there are two aggregate shocks a standard productivity shock and a noise shock affecting public beliefs about aggregate productivity neither the central bank nor individual agents can distinguish the two shocks when they are realized despite the lack of superior information monetary policy can affect the economy s relative response to the two shocks as time passes better information on past fundamentals becomes available the central bank can then adopt a backward looking policy rule based on more precise information about past shocks by announcing its response to future information the central bank can influence the expected real interest rate faced by forward looking consumers with different beliefs and thus affect the equilibrium allocation if the announced future response is sufficiently aggressive the central bank can completely eliminate the effect of noise shocks however this policy is typically suboptimal as it leads to an excessively compressed distribution of relative prices the optimal monetary policy balances the benefits of aggregate stabilization with the costs in terms of cross sectional efficiency copyright wiley blackwell

robust control informational frictions and international consumption correlations abstract in this paper we examine the effects of model misspecification robustness or rb on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation we show that in the presence of capital mobility in financial markets rb lowers the international consumption correlations by generating heterogeneous responses of consumption to productivity shocks across countries facing different macroeconomic uncertainty in addition we show that rb can also improve the model s predictions in three other moments of consumption dynamics the relative volatility of consumption to income the persistence of consumption and the correlation between consumption and output after calibrating the rb parameter using the detection error probabilities we show that the model can explain the observed international consumption correlations as well as the other consumption moments quantitatively finally we show that the main conclusions of our benchmark model do not change in an extension in which the agent cannot observe the state perfectly due to finite information processing capacity