NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Monetary Policy with Informational Frictions

George-Marios Angeletos, Jennifer La'O

NBER Working Paper No. 17525
Issued in November 2011, Revised in March 2018
NBER Program(s):Economic Fluctuations and Growth, Monetary Economics

This paper studies optimal policy in a business-cycle setting in which firms have a blurry understanding of the state of the economy due to informational or cognitive constraints. The latter are not only the source of nominal rigidity but also an impediment in the coordination of production. The optimal allocation thus differs from familiar Ramsey benchmarks (Lucas and Stokey, 1983; Correia, Nicolini, and Teles, 2008) in manners that may be misinterpreted as a call for macroeconomic stabilization. Furthermore, conventional policy instruments serve new functions: they manipulate the firms’ collection and use of information or their cognitive efforts. Despite these facts, the optimal taxes are similar to those in the aforementioned benchmarks and the optimal monetary policy replicates flexible-price allocations. On the other hand, the rationale for price stability falls apart: replicating flexible-price allocations and minimizing relative-price distortions become equivalent to a certain form of “leaning against the wind”.

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Document Object Identifier (DOI): 10.3386/w17525

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