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Université de Lausanne
Faculté des HEC
Département d'économétrie et d'économie politique

Cahier de recherches économiques du DEEP No. 17.14

Kenza Benhima and Isabella Blengini


Optimal Monetary Policy when Information is Market-Generated

July, 2017

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.

JEL Classification: D83, E32, E52

Keywords: Optimal monetary policy, information frictions, expectations, central bank communication

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