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Imperfect Common Knowledge and the Effects of Monetary Policy

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Michael Woodford

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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8673.

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Date of creation: Dec 2001
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Handle: RePEc:nbr:nberwo:8673

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D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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This page was last updated on 2009-11-13.

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