IDEAS home Printed from https://ideas.repec.org/a/eee/jmacro/v33y2011i2p259-275.html
   My bibliography  Save this article

An explanation for the price puzzle: Asymmetric information and expectation dynamics

Author

Listed:
  • Tas, Bedri Kamil Onur

Abstract

Using theoretical and empirical analyses, this paper shows that the expectation dynamics induced by information asymmetry between the Central Bank (CB) and the public can cause the price puzzle. The signalling and learning dynamics between the CB and a representative private-sector agent under asymmetric information is investigated. Inflation positively reacts to contractionary monetary policy because the change in the interest rate is perceived as a signal of the CB's private information about higher future inflation and output by the public. The empirical section of the paper validates this theoretical argument using a VAR specification about the US economy. Besides providing an explanation for the price puzzle, the results of this paper has practical implications about transparency and monetary policy. The theoretical and empirical findings indicate that asymmetric information causes significant frictions in the transmission mechanism of monetary policy. These frictions induce short-run undesired effects like increase in expected inflation and actual inflation as a response to contractionary monetary policy which is identified as "the price puzzle".

Suggested Citation

  • Tas, Bedri Kamil Onur, 2011. "An explanation for the price puzzle: Asymmetric information and expectation dynamics," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 259-275, June.
    • Handle: RePEc:eee:jmacro:v:33:y:2011:i:2:p:259-275
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0164-0704(10)00087-X
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Susan Athey & Andrew Atkeson & Patrick J. Kehoe, 2005. "The Optimal Degree of Discretion in Monetary Policy," Econometrica, Econometric Society, vol. 73(5), pages 1431-1475, September.
    2. Faust Jon & Swanson Eric T & Wright Jonathan H, 2004. "Do Federal Reserve Policy Surprises Reveal Superior Information about the Economy?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-31, October.
    3. Joe Peek & Eric S. Rosengren & Geoffrey M. B. Tootell, 1999. "Is Bank Supervision Central to Central Banking?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 629-653.
    4. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
    5. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
    6. Christopher A. Sims, 2002. "The Role of Models and Probabilities in the Monetary Policy Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 1-62.
    7. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    8. Nergiz Dincer & Barry Eichengreen, 2009. "Central Bank Transparency: Causes, Consequences and Updates," NBER Working Papers 14791, National Bureau of Economic Research, Inc.
    9. Refet S Gürkaynak & Andrew Levin & Eric Swanson, 2010. "Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from the U.S., UK, and Sweden," Journal of the European Economic Association, MIT Press, vol. 8(6), pages 1208-1242, December.
    10. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270.
    11. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 869-902.
    12. Svensson, Lars E. O. & Woodford, Michael, 2003. "Indicator variables for optimal policy," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 691-720, April.
    13. Bernanke, Ben S. & Boivin, Jean, 2003. "Monetary policy in a data-rich environment," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 525-546, April.
    14. Castelnuovo, Efrem, 2003. "Taylor rules, omitted variables, and interest rate smoothing in the US," Economics Letters, Elsevier, vol. 81(1), pages 55-59, October.
    15. Giordani, Paolo, 2004. "An alternative explanation of the price puzzle," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1271-1296, September.
    16. Efrem Castelnuovo & Paolo Surico, 2005. "The Price Puzzle: Fact or Artefact?," Macroeconomics 0505015, University Library of Munich, Germany, revised 19 Jul 2005.
    17. Gordon, David B & Leeper, Eric M, 1994. "The Dynamic Impacts of Monetary Policy: An Exercise in Tentative Identification," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1228-1247, December.
    18. Carlstrom, Charles T. & Fuerst, Timothy S. & Paustian, Matthias, 2009. "Monetary policy shocks, Choleski identification, and DNK models," Journal of Monetary Economics, Elsevier, vol. 56(7), pages 1014-1021, October.
    19. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-397, May.
    20. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
    21. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    22. English William B. & Nelson William R. & Sack Brian P., 2003. "Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-18, April.
    23. David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
    24. Jean Boivin & Marc P. Giannoni, 2006. "Has Monetary Policy Become More Effective?," The Review of Economics and Statistics, MIT Press, vol. 88(3), pages 445-462, August.
    25. Lars E. O. Svensson, 1999. "How should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 195-259.
    26. Brissimis, Sophocles N. & Magginas, Nicholas S., 2006. "Forward-looking information in VAR models and the price puzzle," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1225-1234, September.
    27. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    28. Sleet, Christopher, 2001. "On Credible Monetary Policy and Private Government Information," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 338-376, July.
    29. Lloyd B. Thomas, 1999. "Survey Measures of Expected U.S. Inflation," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 125-144, Fall.
    30. Svensson, Lars E. O. & Woodford, Michael, 2004. "Indicator variables for optimal policy under asymmetric information," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 661-690, January.
    31. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 821-852.
    32. International Monetary Fund, 2008. "Is Monetary Policy Effective When Credit is Low?," IMF Working Papers 2008/288, International Monetary Fund.
    33. Mehra Yash P, 2004. "The Output Gap, Expected Future Inflation and Inflation Dynamics: Another Look," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-19, December.
    34. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-588, August.
    35. Rabanal, Pau, 2007. "Does inflation increase after a monetary policy tightening? Answers based on an estimated DSGE model," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 906-937, March.
    36. Yash P. Mehra, 2004. "The output gap, expected future inflation and inflation dynamics: another look," Working Paper 04-06, Federal Reserve Bank of Richmond.
    37. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Cucciniello, Maria Chiara & Deleidi, Matteo & Levrero, Enrico Sergio, 2022. "The cost channel of monetary policy: The case of the United States in the period 1959–2018," Structural Change and Economic Dynamics, Elsevier, vol. 61(C), pages 409-433.
    2. Ida, Daisuke, 2024. "Household heterogeneity and the price puzzle in a new Keynesian model," Journal of Macroeconomics, Elsevier, vol. 79(C).
    3. Estrella, Arturo, 2015. "The Price Puzzle And Var Identification," Macroeconomic Dynamics, Cambridge University Press, vol. 19(8), pages 1880-1887, December.
    4. Taniya Ghosh & Yadavindu Ajit, 2023. "Central bank transparency, the role of institutions and inflation persistence," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2023-012, Indira Gandhi Institute of Development Research, Mumbai, India.
    5. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
    6. Zhang, Ji, 2016. "Macroeconomic news and the real interest rates at the zero lower bound," Journal of Macroeconomics, Elsevier, vol. 48(C), pages 172-185.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. repec:spo:wpecon:info:hdl:2441/f4rshpf3v1umfa09lat09b1bg is not listed on IDEAS
    2. repec:hal:wpspec:info:hdl:2441/f4rshpf3v1umfa09lat09b1bg is not listed on IDEAS
    3. Pierre L. Siklos & Diana N. Weymark, 2008. "Data Revisions, Gradualism, and US Inflation Pressure in Real Time," Vanderbilt University Department of Economics Working Papers 0816, Vanderbilt University Department of Economics.
    4. repec:hal:spmain:info:hdl:2441/f4rshpf3v1umfa09lat09b1bg is not listed on IDEAS
    5. repec:spo:wpmain:info:hdl:2441/f4rshpf3v1umfa09lat09b1bg is not listed on IDEAS
    6. Elmar Mertens, 2016. "Managing Beliefs about Monetary Policy under Discretion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 661-698, June.
    7. Paul Hubert, 2010. "Monetary policy, imperfect information and the expectations channel [Politique monétaire,information imparfaite et canal des anticipations]," SciencePo Working papers Main tel-04095385, HAL.
    8. Sophocles N. Brissimis & Nicholas S. Magginas, 2017. "Monetary Policy Rules Under Heterogeneous Inflation Expectations," Economic Inquiry, Western Economic Association International, vol. 55(3), pages 1400-1415, July.
    9. B. Onur Tas, 2012. "Why does the Federal Reserve Forecast Inflation Better than Everyone Else?," Working Papers 1207, TOBB University of Economics and Technology, Department of Economics.
    10. Patrick Minford & Zhirong Ou & Michael Wickens, 2015. "Revisiting the Great Moderation: Policy or Luck?," Open Economies Review, Springer, vol. 26(2), pages 197-223, April.
    11. Goto, Shingo, 2000. "The Fed's Effect on Excess Returns and Inflation is Much Bigger Than You Think," University of California at Los Angeles, Anderson Graduate School of Management qt04f1z5hb, Anderson Graduate School of Management, UCLA.
    12. Bedri Kamil Onur Tas, 2007. "Inflation Targeting as a Signalling Mechanism," Working Papers 0701, TOBB University of Economics and Technology, Department of Economics.
    13. Minford, Patrick & Ou, Zhirong, 2013. "Taylor Rule or optimal timeless policy? Reconsidering the Fed's behavior since 1982," Economic Modelling, Elsevier, vol. 32(C), pages 113-123.
    14. Tas, Bedri Kamil Onur & Togay, Selahattin, 2010. "Optimal monetary policy regime for oil producing developing economies: Implications for post-war Iraq," Economic Modelling, Elsevier, vol. 27(5), pages 1324-1336, September.
    15. Mr. Christopher W. Crowe & Mr. S. Mahdi Barakchian, 2010. "Monetary Policy Matters: New Evidence Basedon a New Shock Measure," IMF Working Papers 2010/230, International Monetary Fund.
    16. Chengsi Zhang & Denise R. Osborn & Dong Heon Kim, 2008. "The New Keynesian Phillips Curve: From Sticky Inflation to Sticky Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 667-699, June.
    17. Brissimis, Sophocles N. & Magginas, Nicholas S., 2006. "Forward-looking information in VAR models and the price puzzle," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1225-1234, September.
    18. Bedri Kamil Onur Tas & Selahattin Togay, 2008. "Optimal Monetary Policy for Postwar Iraq," Working Papers 0813, TOBB University of Economics and Technology, Department of Economics.
    19. Shawn Chen-Yu Leu, 2006. "A New Keynesian Perspective of Monetary Policy in Australia," Working Papers 2006.01, School of Economics, La Trobe University.
    20. Ramón Maria-Dolores & Jesus Vazquez, 2006. "The relative importance of Term Spread, Policy Inertia and Persistent Monetary Policy Shocks in Monetary Policy Rules," Computing in Economics and Finance 2006 6, Society for Computational Economics.
    21. Lavan Mahadeva, 2007. "A model of market surprises," Bank of England working papers 327, Bank of England.
    22. Geert Bekaert & Seonghoon Cho & Antonio Moreno, 2010. "New Keynesian Macroeconomics and the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(1), pages 33-62, February.
    23. John W. Keating & Logan J. Kelly & A. Lee Smith & Victor J. Valcarcel, 2019. "A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(1), pages 227-259, February.
    24. Paul Hubert, 2015. "Revisiting the Greenbook’s relative forecasting performance," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 151-179.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jmacro:v:33:y:2011:i:2:p:259-275. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/622617 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.