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How Important Is the Information Effect of Monetary Policy?

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Abstract

Is the "information effect" of monetary policy quantitatively important? We first use a simple model to show that under asymmetric information, monetary policy surprises are correlated with the unobserved state of the economy. This correlation implies that monetary policy surprises provide information about the state of the economy, and at the same time, explains why the estimation of the information effect may be biased. We then develop a New Keynesian DSGE model under asymmetric information and calibrate model parameters to match macroeconomic dynamics in the US and forecasting accuracy in the Greenbook. Under our calibration, both the central bank and the private sector initially have noisy information. Over time, the information effect of monetary policy mitigates information frictions by enhancing the two-way learning between the central bank and the private sector.

Suggested Citation

  • Zhao Han & Chengcheng Jia, 2023. "How Important Is the Information Effect of Monetary Policy?," Working Papers 23-32, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwq:97469
    DOI: 10.26509/frbc-wp-202332
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    References listed on IDEAS

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    1. Han, Zhao & Tan, Fei & Wu, Jieran, 2022. "Analytic policy function iteration," Journal of Economic Theory, Elsevier, vol. 200(C).
    2. Kurt G. Lunsford, 2020. "Policy Language and Information Effects in the Early Days of Federal Reserve Forward Guidance," American Economic Review, American Economic Association, vol. 110(9), pages 2899-2934, September.
    3. Michael D. Bauer & Eric T. Swanson, 2023. "An Alternative Explanation for the "Fed Information Effect"," American Economic Review, American Economic Association, vol. 113(3), pages 664-700, March.
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    More about this item

    Keywords

    monetary policy; information frictions; asymmetric information;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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