An explanation for the price puzzle: Asymmetric information and expectation dynamics

Bedri Kamil Onur Tas*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

4 Citations (Scopus)

Abstract

Using theoretical and empirical analyses, this paper shows that the expectation dynamics induced by information asymmetry between the Central Bank (CB) and the public can cause the price puzzle. The signalling and learning dynamics between the CB and a representative private-sector agent under asymmetric information is investigated. Inflation positively reacts to contractionary monetary policy because the change in the interest rate is perceived as a signal of the CB's private information about higher future inflation and output by the public. The empirical section of the paper validates this theoretical argument using a VAR specification about the US economy. Besides providing an explanation for the price puzzle, the results of this paper has practical implications about transparency and monetary policy. The theoretical and empirical findings indicate that asymmetric information causes significant frictions in the transmission mechanism of monetary policy. These frictions induce short-run undesired effects like increase in expected inflation and actual inflation as a response to contractionary monetary policy which is identified as "the price puzzle"

Original languageEnglish
Pages (from-to)259-275
Number of pages17
JournalJournal of Macroeconomics
Volume33
Issue number2
DOIs
Publication statusPublished - Jun 2011
Externally publishedYes

Keywords

  • Asymmetric information
  • Kalman filter
  • Learning
  • Monetary policy
  • Price puzzle
  • VAR models

ASJC Scopus subject areas

  • Economics and Econometrics

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