Volatile policy and private information: The case of monetary shocks

We study how volatility in monetary policy affects economic performance in the presence of asymmetric information and endogenously chosen information structures. We consider a model in which in the absence of either feature the equilibria would be efficient. The equilibria that we find are inefficient for two reasons: first, in some cases, agents fail to trade, even though it is efficient to do so; second, agents spend resources acquiring socially useless information. The model predicts a nonlinear relationship between inflation and output and a complex pattern of price dispersion, with the nature of the relationship changing with the degree of volatility. (C) 2001 Academic Press.