The Signal Extraction Problem Revisited: A Note on Its Impact on a Model of Monetary Policy

Abstract

This paper develops a dynamic stochastic general equilibrium (DSGE) model with sticky prices and sticky wages, in which agents have imperfect information on the stance and direction of monetary policy. Agents respond by using Kalman filtering to unravel persistent and temporary monetary policy changes in order to form optimal forecasts of future policy actions. Our results show that a New Keynesian model with imperfect information and real rigidities can account for several key effects of an expansionary monetary policy shock: the hump-shaped increase in output, the delayed and gradual rise in inflation, and the fall in the nominal interest rate.

Information, heterogeneity and market incompleteness

“…We further show that consumption in our economy is in general not certainty-equivalent (in the sense of Pearlman et al, 1986or Svennson and Woodford, 2002, 2004. We then study the model numerically and …nd it di¤ers dramatically from the complete markets economy.…”

“…The …rst strand looks at the problem of setting monetary policy under imperfect information. Most such models (Pearlman et al, 1986, Svennson and Woodford, 2002, 2004, Aoki, 2003 look at the problem of asymmetric information when the monetary policymaker has imperfect information but the private sector is perfectly informed. Pearlman (1992) and Svennson and Woodford (2003) look at the case where the private sector and the policymaker share the same imperfect information set.…”

“…Keen (2004) investigates a model in which the private sector is poorly informed about the behaviour of the monetary policymaker and concludes that it can account for several business cycle features better than the standard model. In Collard and Dellas (2006), the introduction of imperfect information in an otherwise standard dynamic new Keynesian model can generate in ‡ation persistence, hump-shaped dynamics of in ‡ation and output and a liquidity e¤ect.…”

The hump-shaped behavior of inflation and a dynamic externality

“…They model serially correlated forecast errors with learning. Although Erceg and Levin (2003) did not show a hump-shaped IRF for inflation, Keen (2003), following the same idea as Erceg and Levin (2003), showed the inflation is hump-shaped in response to a monetary shock when imperfect information exists between private sectors and the central bank.…”