Asymmetric Information, Two-Way Learning, and the Fed Information Effect

Zhao Han and Chengcheng Jia

No 23-32R, Working Papers from Federal Reserve Bank of Cleveland

Abstract: How important is the information effect of monetary policy? We first show analytically that the reduced-form method of regressing forecast revisions on monetary policy surprises leads to a biased estimation, due to the correlation between monetary policy surprises and the unobserved shocks. We then develop a New Keynesian model in which asymmetric information originates from a two-way learning mechanism: the central bank learns from lagged aggregate inflation and output, and firms learn from individual marginal costs and the interest rate. We calibrate our model parameters to match macroeconomic dynamics in the US and the forecast accuracy of the Federal Reserve and professional forecasters. Our calibrated model shows that the information effect reduces the output gaps caused by demand shocks and noise shocks, but may lead to a temporary rise in inflation after a contractionary monetary policy shock.

Keywords: information frictions; expectations; monetary policy; central bank communications (search for similar items in EconPapers)
JEL-codes: D84 E52 E58 (search for similar items in EconPapers)
Pages: 44
Date: 2023-12-18, Revised 2025-10-02
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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DOI: 10.26509/frbc-wp-202332r

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