Social Sciences, Business, Finance, Economics, Business & Economics, New Keynesian model, Imperfect information, Signal extraction, Bayesian estimation, MONETARY-POLICY, INFLATION DYNAMICS, MODEL, NEUTRALITY, SHOCKS, 1402 Applied Economics, 1401 Economic Theory, 1403 Econometrics
Imperfect information has played a prominent role in modern business cycle theory. This paper assesses its importance by estimating the new Keynesian (NK) model under alternative informational assumptions. One version focuses on confusion between temporary and persistent disturbances. Another, on unobserved variation in the inflation target of the Central Bank. A third on persistent mis-perceptions of the state of the economy (measurement error). And a fourth assumes perfect information (the standard NK-DSGE version). Imperfect information is found to contain considerable explanatory power for business fluctuations. Signal extraction seems to provide a conceptually satisfactory, empirically plausible and quantitatively important business cycle mechanism.