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Imperfect Information, Shock Heterogeneity, and Inflation Dynamics

Author

Listed:
  • Tatsushi Okuda

    (Deputy Director and Economist, Institute for Monetary and Economic Studies (currently, Research and Statistics Department), Bank of Japan (E-mail: tatsushi.okuda@boj.or.jp))

  • Tomohiro Tsuruga

    (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, International Monetary Fund, E-mail: TTsuruga@imf.org))

  • Francesco Zanetti

    (University of Oxford (E-mail: francesco.zanetti@ economics.ox.ac.uk))

Abstract
We establish important empirical regularities on firms' expectations about aggregate and idiosyncratic components of sectoral demand using industry-level survey data for the universe of Japanese firms. Expectations about the idiosyncratic component of demand differ across sectors, and they positively co-move with those about aggregate component. To study the implications for firms' price setting, we develop a theoretical framework that captures systematic features in firms' expectation formation based on inference of different shocks from a common signal--a chief modelling approach to imperfect information. We show that the sensitivity of inflation to changes in demand decreases with the volatility of idiosyncratic component of demand that proxies the degree of shock heterogeneity. We use principal component analysis on Japanese sectoral-level data to estimate the degree of shock heterogeneity, and we establish that the observed increase in shock heterogeneity plays a significant role for the reduced sensitivity of inflation to movements in real activity since the late 1990s.

Suggested Citation

  • Tatsushi Okuda & Tomohiro Tsuruga & Francesco Zanetti, 2019. "Imperfect Information, Shock Heterogeneity, and Inflation Dynamics," IMES Discussion Paper Series 19-E-15, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:19-e-15
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    References listed on IDEAS

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    Cited by:

    1. David Finck & Peter Tillmann, 2022. "The Role of Global and Domestic Shocks for Inflation Dynamics: Evidence from Asia," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 84(5), pages 1181-1208, October.
    2. Juan Angel Garcia & Aubrey Poon, 2022. "Inflation trends in Asia: implications for central banks [Are Phillips curves useful for forecasting inflation?]," Oxford Economic Papers, Oxford University Press, vol. 74(3), pages 671-700.
    3. Adriana Cornea‐Madeira & João Madeira, 2022. "Econometric Analysis of Switching Expectations in UK Inflation," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 84(3), pages 651-673, June.
    4. Dur, Ayşe & Martínez García, Enrique, 2020. "Mind the gap!—A monetarist view of the open-economy Phillips curve," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).

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    More about this item

    Keywords

    Imperfect information; Shock heterogeneity; Inflation dynamics;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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