Abstract
We study optimal policy in a business-cycle setting in which firms hold dispersed private information about, or are rationally inattentive to, the state of the economy. The informational friction is the source of both nominal and real rigidity. Because of the latter, the optimal monetary policy does not target price stability. Instead, it targets a negative relation between the nominal price level and real economic activity. Such leaning against the wind helps maximize production efficiency. An additional contribution is the adaptation of the primal approach of the Ramsey literature to a flexible form of informational friction.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 1027-1064 |
| Number of pages | 38 |
| Journal | Journal of Political Economy |
| Volume | 128 |
| Issue number | 3 |
| DOIs | |
| State | Published - Mar 1 2020 |
Funding
This paper extends, and subsumes, earlier drafts that concerned the same topic but contained a narrower methodological contribution (Angeletos and La’O 2008, 2011). We are particularly grateful to the editor, Harald Uhlig, and three anonymous referees for detailed and constructive feedback on the latest version. We thank Robert King and Philippe Bac-chetta for discussing early versions of our paper and Karthik Sastry for research assistance. We also benefited from comments received in numerous conferences and seminars. Finally, Angeletos acknowledges that this material is based in part upon work supported by the National Science Foundation under grant SES-175719.
ASJC Scopus subject areas
- Economics and Econometrics