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Imperfect Common Knowledge and the Effects of Monetary Policy

Michael Woodford ()

No 8673, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper reconsiders the Phelps-Lucas hypothesis, according to which temporary real effects of purely nominal disturbances result from imperfect information, but departs from the assumptions of Lucas (1973) in two crucial respects. Due to monopolistically competitive pricing, higher-order expectations are crucial for aggregate inflation dynamics, as argued by Phelps (1983). And decisionmakers' subjective perceptions of current conditions are assumed to be of imperfect precision, owing to finite information processing capacity, as argued by Sims (2001). The model can explain highly persistent real effects of a monetary disturbance, and a delayed effect on inflation, as found in VAR studies.

JEL-codes: D82 E32 (search for similar items in EconPapers)
Date: 2001-12
New Economics Papers: this item is included in nep-cba and nep-mon
Note: EFG ME
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Published as Aghion, P., R. Frydman, J. Stiglitz, and M. Woodford (eds.) Knowledge, Information and Expectations in Modern Macroeconomics. Princeton: Princeton University Press, 2002.

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