Information Flows and Aggregate Persistence

This paper studies the effect of imperfect information on aggregate output and price dynamics. I argue that imperfect information can lead monetary shocks to have persistent real effects. In the environment with unobserved aggregate (monetary) and real demand shocks, price-setting agents face fixed costs of updating to full information. Between full updating, agents use market prices and quantities to infer the state of the economy. The economy is more informative if (a) the fraction of fully updating agents is high; (b) shocks to the money supply are more volatile than the sector-specific shocks; and (c) the degree of real rigidity is small. I find that the effect of monetary shocks on output and inflation is bigger in economy that is less informative. Dynamics in uninformative economies can be well approximated by the equilibrium where signals convey no information, as in Mankiw and Reis (2002).