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Optimal Monetary Policy when Information is Market-Generated

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  • Kenza Benhima
  • Isabella Blengini

Abstract

Endogenous - i.e. market-generated - signals observed by firms have crucial implications for monetary policy. When information is endogenous, firms gather a demand signal from their market that is both real and nominal. As a result, the traditional surprise channel of monetary policy is absent. Instead, monetary policy works through a signaling channel, as it affects firms' information through the demand signal. The optimal policy is then the signaling policy, i.e. the policy that maximizes the information content of the demand signal. In our setup, the signaling policy targets a positive correlation between money supply and prices, which emphasizes the natural response of prices to real shocks. On the contrary, in the more traditional case of exogenous information, optimal monetary policy would stabilize prices as it acts through the surprise channel. We show that the signaling policy is optimal regardless of the amount of attention that firms pay to central bank communication.

Suggested Citation

  • Kenza Benhima & Isabella Blengini, 2017. "Optimal Monetary Policy when Information is Market-Generated," Cahiers de Recherches Economiques du Département d'économie 17.14, Université de Lausanne, Faculté des HEC, Département d’économie.
    • Handle: RePEc:lau:crdeep:17.14
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    Cited by:

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    3. Ryan Chahrour & Gaetano Gaballo, 2021. "Learning from House Prices: Amplification and Business Fluctuations [House Price Booms and the Current Account]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(4), pages 1720-1759.
    4. Jonathan J Adams, 2024. "Optimal Policy Without Rational Expectations: A Sufficient Statistic Solution," Working Papers 001011, University of Florida, Department of Economics.
    5. Markus Heckel & Kiyohiko G. Nishimura, 2020. "Unconventional Monetary Policy through Open Market Operations: A Principal Component Analysis," CARF F-Series CARF-F-501, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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    More about this item

    Keywords

    Optimal monetary policy; information frictions; expectations; central bank communication;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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