Incomplete information, higher-order beliefs and price inertia
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Angeletos-LaO-JME.pdf
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article
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Author(s)
Angeletos, George-Marios
La'O, Jennifer
Date Issued
July 2009
Journal
Journal of Monetary Economics
Publisher
Elsevier
Citation
Angeletos, George-Marios, and Jennifer La'O. “Incomplete information, higher-order beliefs and price inertia.” Journal of Monetary Economics 56.Supplement 1 (2009): S19-S37.
Version
Author's final manuscript
Abstract
This paper investigates how incomplete information impacts the response of prices to nominal
shocks. Our baseline model is a variant of the Calvo model in which firms observe the underlying
nominal shocks with noise. In this model, the response of prices is pinned down by three
parameters: the precision of available information about the nominal shock; the frequency of
price adjustment; and the degree of strategic complementarity in pricing decisions. This result
synthesizes the broader lessons of the pertinent literature. We next highlight that this synthesis
provides only a partial view of the role of incomplete information. In general, the precision
of information does not pin down the response of higher-order beliefs. Therefore, one cannot
quantify the degree of price inertia without additional information about the dynamics of higherorder
beliefs, or the agents’ forecasts of inflation. We highlight the distinct role of higher-order
beliefs with three extensions of our baseline model, all of which break the tight connection
between the precision of information and higher-order beliefs featured in previous work.
MIT Department
Massachusetts Institute of Technology. Department of Economics
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DOI of Published Version
http://dx.doi.org/10.1016/j.jmoneco.2009.07.001
