Incomplete information, higher order beliefs, and price inertia
By: [by] George-Marios Angeletos [and] Jennifer La'O
Contributors: La'O, Jennifer; Massachusetts Institute of Technology. Dept. of Economics
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 09-18; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 09-18.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2009
Place of publication: Cambridge, MA
Language: eng
Number of pages: 37
Description: This paper investigates who incomplete information impacts the response of prices to nominal shocks. Our baseline model is a variant of the Calvo model in which firms observe the underlying nominal shocks with noise. In this model, the response of prices is pinned down by three parameters: the precision of available information about the nominal shock; the frequency of price adjustment; and the degree of strategic complementarity in pricing decisions. This result synthesizes the broader lessons of the pertinent literature. We next highlight that his synthesis provides only a partial view of the role or incomplete information. In general, the precision of information does not pin down the response of higher-order beliefs. Therefore, once cannot quantify the degree of price inertia without additional information about the dynamics of higher-order beliefs, or the agents' forecasts of inflation. We highlight the distinct role of higher-order beliefs with three extensions of our baseline model, all of which break the tight connection between the precision of information and higher-order beliefs featured in previous work. Keywords: Business cycles, fluctuations, heterogeneous information, informational frictions, noise, strategic complementarity, higher-order beliefs. JEL Classifications: C7, D6, D8.
Notes: "March 31, 2009."

Includes bibliographical references (p. 35-37).

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