DP409 | Credibility, Ambiguity and Asymmetric Information with Wage/Price Stickiness

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The effect of asymmetric information on monetary policy is investigated in the context of an overlapping wage contract model. Optimal rules with and without precommitment under full information are compared with the optimal rule without precommitment (i.e. the discretionary rule) under asymmetric information. The results extend those of Cukierman and Meltzer (1986) to a dynamic model with a short-run output/inflation trade-off. The optimal discretionary rate is less than that under full information and there is also a role for ambiguity in the setting of monetary policy. Both these effects of asymmetric information diminish as the average length of wage contracts increases.