Working Paper: NBER ID: w7072
Authors: Larry E. Jones; Rodolfo E. Manuelli
Abstract: In this paper we study how volatility in monetary policy affects economic performance in the presence of endogenously chosen information structures. To isolate the effects produced by the interaction of uncertainty in monetary policy and (possibly) asymmetric information, we consider a model in which in the absence of either one of these features the equilibrium would be efficient. The equilibria that we find, with volatility and asymmetry of information, are inefficient for two reasons: first, in some cases, economic agents fail to trade, even though it is always efficient to do so; second, to capture the rents associated with being informed, agents spend resources acquiring socially useless information. Thus, in addition to the more standard effects of volatile inflation, our model calls attention to two types of costs associated with monetary uncertainty: the cost of not trading, and the cost of allocating resources to wasteful activities. The model implies that if monetary policy is not volatile all agents are symmetrically informed and hence, the outcome is efficient. Alternatively, making policy transparent,' i.e guaranteeing that all agents share the same information, serves the same purpose.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Volatility in monetary policy (E63) | inefficiencies in economic equilibria (D59) |
| Volatility in monetary policy (E63) | agents fail to trade when they should (D82) |
| Volatility in monetary policy (E63) | agents allocate resources to acquire socially useless information (D82) |
| Stable monetary policy (E63) | efficient outcomes (D61) |
| Stable monetary policy (E63) | all agents are symmetrically informed (D82) |
| Monetary policy volatility + asymmetric information (E49) | economic inefficiencies (D61) |