Finance and Economics Discussion Series

Imperfect Information and Monetary Models: Multiple Shocks and their Consequences

Leon W. Berkelmans
2008-58

Abstract: This paper examines the role of multiple aggregate shocks in monetary models with imperfect information. Because agents can draw mistaken inferences about which shock has occurred, the existence of multiple aggregate shocks profoundly influences macroeconomic dynamics. In particular, after a contractionary monetary shock these models can generate an initial increase in inflation (the "price puzzle") and a delayed disinflation (a "hump"). A conservative numerical illustration exhibits these patterns. In addition, the model shows that increased price flexibility is potentially destabilizing.

Keywords: Imperfect information, price puzzle, inflation inertia