An Explanation for the Price Puzzle: Asymmetric Information and Expectation Dynamics

Posted: 5 Sep 2011

See all articles by Bedri Kamil Onur Tas

Bedri Kamil Onur Tas

TOBB University of Economics and Technology - Department of Economics; Economic Research Forum (ERF)

Date Written: September 5, 2011

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”.

Keywords: Price puzzle, Asymmetric information, VAR models, Monetary policy, Kalman filter, Learning

JEL Classification: C32, D82, D83, E31, E52

Suggested Citation

Tas, Bedri Kamil Onur, An Explanation for the Price Puzzle: Asymmetric Information and Expectation Dynamics (September 5, 2011). Journal of Macroeconomics, Vol. 33, No. 2, 2011, Available at SSRN: https://ssrn.com/abstract=1922538

Bedri Kamil Onur Tas (Contact Author)

TOBB University of Economics and Technology - Department of Economics ( email )

Sogutozu Cad. No:43 Sogutozu
Ankara, 06560
Turkey

HOME PAGE: http://onurtas.weebly.com

Economic Research Forum (ERF) ( email )

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Dokki, Cairo
Egypt

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