Volatile Policy and Private Information: The Case of Monetary Policy

Larry E. Jones, Rodolfo E. Manuelli

NBER Working Paper No. 7072
Issued in April 1999
NBER Program(s):Economic Fluctuations and Growth

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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Document Object Identifier (DOI): 10.3386/w7072

Published: Jones, Larry E. and Rodolfo E. Manuelli. "Volatile Policy And Private Information: The Case Of Monetary Shocks," Journal of Economic Theory, 2001, v99(1/2,Jul/Aug), 265-326.

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