Dispersed information, nominal rigidities and monetary business cycles: A Hayekian perspective

We study the propagation of nominal shocks in a dispersed information economy where firms learn from and respond to information generated by their activities in product and factor markets. We show that imperfect information on its own has no effect on equilibrium outcomes, when firms have the flexibility to adjust prices and output instantaneously to changes in their market conditions, an outcome that we term the “Hayekian benchmark”. With sticky prices, however, this irrelevance obtains only if there are no strategic complementarities in pricing and aggregate and idiosyncratic shocks are equally persistent. With complementarities and/or differences in persistence, the interaction of nominal and informational frictions slows down price adjustment, amplifying real effects from nominal shocks (relative to a full information model with only nominal frictions). In a calibrated model, the amplification is most pronounced over the medium to long term. In the short run, market generated information leads to substantial aggregate price adjustment, even though firms may be completely unaware of changes in aggregate conditions. • Hayekian benchmark: Market signals allow firms to act as if they were fully informed. • With flexible prices, market signals alone suffice to attain full information outcome. • With sticky prices + complementarities, Hayekian benchmark is no longer attainable. • Instead, incomplete info amplifies real effects of monetary shocks with sticky prices. • Amplification is modest in the short run, but stronger at medium to long horizons.