Working Paper: CEPR ID: DP13817
Authors: Kenza Benhima; Isabella Blengini
Abstract: The nature of the private sector's information changes the optimal conduct of monetary policy. When fi rms observe their individual demand and use it as a signal of real shocks, the optimal policy consists in maximizing the information content of that signal. When real shocks are defl ationary (like labor supply shocks), the optimal policy is countercyclical and magni fies price movements, which contrasts with the exogenous information case, where optimal monetary policy is procyclical and stabilizes prices. When the central bank communicates its information to the public, this policy is still optimal if fi rms pay limited attention to central bank announcements.
Keywords: optimal monetary policy; information frictions; endogenous information; expectations; central bank communication
JEL Codes: D83; E32; E52; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central Bank's signaling policy (E52) | firms' pricing decisions (L11) |
| firms' individual demand as endogenous signal (D22) | traditional surprise channel of monetary policy disappears (E49) |
| Central Bank's optimal strategy shifts to signaling policy (E52) | firms set prices more accurately (L11) |
| Central Bank's signaling policy (E52) | correlation of nominal demand with real shocks (C51) |
| optimal monetary policy maximizes information content of market variables (E63) | firms learn from local market (L19) |
| Central Bank's signaling policy (E52) | enhances signal firms receive from demand (J23) |