Abstract

This paper studies optimal policy in a business-cycle setting in which firms hold dispersed private information about the state of the economy, or have a blurry understanding about it due to rational inattention. The informational friction is not only the source of nominal rigidity but also an impediment to the coordination of production. The main lesson is that the optimal monetary policy does not target price stability; instead, it leans against the wind in the sense of targeting a negative relation between the nominal price level and real economic activity. This policy serves the goal of inducing the firms to utilize their information and to coordinate their decisions in the best possible manner. An additional contribution is the adaptation of the primal approach of the Ramsey literature to a setting with a rich form of informational friction.

joint with George-Marios Angeletos