Information Aggregation and Policy

The function of monetary policy to alter the informational content of money price signals is examined in a model where traders can observe an economy wide financial signal and a local commodity price. Under a passive policy, money demand disturbances, which are not directly observable, are shown to be confused with real productivity shocks and thereby preclude prices from fully reflecting all information. Even when the policy authority has no informational advantage, prospective money growth feedback rules can "improve" the structure of available information. Applications of the rational expectations hypothesis to monetary theory have focused on the informational aspects of money price signals. A key element of the models of Lucas (1972, 1975), Barro (1976), and Sargent and Wallace (1975) is that agents have limited powers of information acquisition and use prices as imperfect summaries from the rest of the world. Those works have suggested that monetary policy can affect the informational content of observed price signals and thereby affect real variables. In Weiss (1980a) it was shown systematic money growth feedback rules can contribute to economic efficiency when the money demands of one group are based on factors not directly observed by all. In this context, monetary policy can alter the information content transmitted from the informed to the uninformed through observation of nominal price signals. A limitation of these analyses is the omission of economy wide financial signals. Clearly, stock and bond prices are observed accurately and costlessly. Empirically, there are strong comovements between financial signals and economic activity. Traditional Keynesian theory argues that financial signals exert an important influence on output by affecting the demand for new capital goods. Understanding the informational role of such signals is crucial to any theory which explains fluctuations as arising from incomplete information. The present analysis investigates the structure of available information with its implications for real variables in a model where agents trade on both an economy wide capital market and a local commodity market. The model has positive implications for the comovements of money demand disturbances, aggregate investment, expected and realized returns, as well as normative implications for the conduct of policy. The structure of exogenous information in the model differs from that of my earlier paper. Rather than assuming two types of traders, informed and uninformed, the model considers traders to have symmetric, although noisy, exogenous private information. In this framework, the economy wide market both aggregates and transmits individuals' information about an aggregate structural variable. This modification is both analytically convenient and illustrates how noise in the price system alters the importance of public relative to private sources of information. The idea that prices aggregate individual information was first formalized in Grossman (1976). In that paper, a non-monetary model of a speculative market was developed in which the price system conveyed all relevant information so as to yield an efficient allocation. However, this feature was also shown to break down if prices are influenced by