Incomplete Information, Higher-Order Beliefs and Price Inertia

George-Marios Angeletos () and Jennifer La'O ()

No 15003, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: D8 E1 E3 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba
Date: 2009-05
Note: EFG ME
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