Monetary, Fiscal and Structural Policies with Heterogeneous Agents

Ongoing Project
POLHIA PB-4
Objectives of
the research
Scientific approach /
methodology
New knowledge and/or
European added value
Monetary, Fiscal and Structural Policies with
Heterogeneous Agents
The Welfare Implications of Information Provision
Luca Colombo and Gianluca Femminis
SUMMARY
PB-4 summarizes the results of a paper by Luca Colombo and
Gianluca Femminis on the welfare implications of the
acquisition and use of information when agents' actions (output
choices, price setting, investment decisions) are interdependent
in that they are either strategic complement or substitutes.
The authors develop a strategic choice framework with
perfect information in which individual actions are taken based
on the observation of public and private signals, whose
precisions are set at a cost by a policy maker and by private
agents, respectively. The timing of the model is such that in
setting the precision of the public signal, the policy maker –
acting as a leader – optimally exploits the fact that an increase
in the precision of public information reduces the incentives for
private acquisition of information, thereby inducing socially
valuable savings of private resources. Agents' expectations on
the fundamentals are updated, using public and private
information, based on Bayes' rule.
The authors find that, when information is costly, the welfare
effects of information provision/acquisition depend crucially on
the degree of complementarity/substitutability between
agents' actions, as well as on the private incentives to acquire
information, and on the dispersion of agents' actions.
It is shown that in monetary economies characterized by
monopolistic competition price setting the elasticity of
substitution between goods provides an incentive for individual
firms to coordinate production choices. The equilibrium level of

Key messages for
policy-makers,
businesses,
trade unions and
civil society actors
coordination remains however inefficiently low as firms fail to
fully internalize the negative effects of prices dispersion on the
allocation of resources. In this respect, the acquisition of
idiosyncratic information, by increasing price dispersion,
further reduces the coordination of production resulting in lower
welfare. It is shown that taxing the acquisition of more precise
private information by firms it is a viable tool to improve over the
equilibrium allocations.
If the acquisition of precise private information by private agents
may have ambiguous welfare effects when strategic
complementarities matter, the authors show that the provision of
more precise public information has generically welfare
improving effects. This result builds a clear pro-transparency
case for policy makers – especially central banks – that should
provide reliable and precise indicators on the key
macroeconomic and monetary variables. Furthermore, when
agents' actions coordination matters, public information tends to
crowd-out private information, reducing agents' incentives to
collect individual signals. This reduces the likelihood that
business cycles are driven by information dispersion, hence also
reducing the importance of information management policies
(versus active monetary and fiscal policies) in smoothing the
cycle.

Objectives of
the research
Scientific approach /
methodology
PROJECT IDENTITY 3
Coordination issues play a key role in many economic
environments, ranging from price setting in imperfectly
competitive market, to investment in presence of network
externalities, to output setting in the presence of negative
externalities such as, e.g., pollution. Whenever strategic
interactions matter, agents' actions depend not only on their
own expectations about the fundamental state of the economy,
but also on their expectations about other agents' beliefs. As
available information differs across agents, different beliefs on
other agents' actions emerge.
While the equilibrium characteristics of such environments
have long been understood, their welfare properties have
started attracting interest more recently. A common feature of
the literature investigating these issues is to assume that
information is freely available. In practice, however, the process
of information acquisition/provision is often far from costless,
which ends up constraining the precision of the information
acquired by private agents and/or provided by public authorities.
To understand how costly information influences agents'
expectations and actions is the goal of the authors' analysis,
who focus in particular on the optimal provision of public
information when coordination among agents' actions matters.
Following Angeletos and Pavan (2007), the authors allow for a
rich modelling environment, characterized by the presence of
dispersed information and by a variety of possible strategic
effects and externalities. As in Angeletos and Pavan (2007), in
the authors' framework the effects of public information on
welfare depend crucially on the degree of strategic
complementarity or substitutability of agents' actions. By
restricting attention to economies with a unique equilibrium and
focusing on symmetric linear equilibria, the authors model
explicitly both the acquisition of private information and the
provision of public information as being costly and
endogenously determined. Moreover, decision making is
modelled in a sequential way: private agents are assumed to
choose the precision of their private information only after
having observed the precision of the public signal provided by a
policy maker. The latter acts therefore as a “Stackelberg leader”,
who optimally exploits the fact that an increase in the precision
of the public signal reduces agents' incentives to acquire private
information, thereby inducing socially valuable savings of
private resources. The assumed timing seems consistent with
the process of information provision/acquisition that is observed
in actual markets. The provision of public information is typically
based on a complex and systematic process of data collection
and processing performed by a bureau for statistics. In turn,
private agents may enjoy a greater flexibility than the statistics
office in acquiring their desired information targets, as they are
not bound to follow standard procedures in acquiring additional

New knowledge and
European added value
PROJECT IDENTITY 4
information. It seems therefore natural to assume that private
agents evaluate the precision of the information provided by the
statistics authority in taking their decisions on the acquisition of
private information.
The authors show that the endogenous choice of the
precision of private signals decreases in the degree of strategic
complementarity among agents' actions. The higher is the
strategic complementarity, the larger are agents' incentives to
align actions, and thus the lower is the weight assigned to the
precision of idiosyncratic information. It is also shown that the
precision of private information is decreasing in its cost, due
to the substitutability between private and public information.
Furthermore, as expected, private information precision is
decreasing in the precision of public information and
increasing in the impact of precision on marginal utility; two
results that stem from entirely obvious cost and utility effects,
respectively.
The optimal precision of the public signal is determined
essentially by the relationship between the costs of public and
private information. In particular, it is shown that the policy
maker has no incentives to provide any public information
whenever the cost of public information is sufficiently larger than
that of private information. Furthermore, as is to be expected,
the precision of the public signal – when provided – is
decreasing in its marginal cost, as well as in the precision of the
fundamental. More interestingly, the value of the cost
threshold determining whether public information of positive
precision is provided depends crucially on the socially optimal
and on the equilibrium degrees of coordination among agents'
actions. The equilibrium degree of agents' actions coordination
has two countervailing effects on information precision. On the
one hand, an increase of the equilibrium degree of coordination
reduces the value that each individual attaches to the precision
of her private signal, which (by augmenting the relative value of
public information) increases the cost threshold. On the other
hand, a positive equilibrium degree of agents' actions
coordination implies that individuals tend to overweight public
information (as stressed by Morris and Shin, 2002). Accordingly,
an increase in the equilibrium degree of coordination has a
detrimental effect on welfare. The authors show that the first
effect dominates even when the cost of public information
precision exceeds that of private information.
A particularly interesting application of the general
framework discussed above concentrates on the welfare
implications of information provision/acquisition in a
monopolistic competition monetary economy, under the
assumption that information precision has a convex cost.
By embedding the main features of models by Hellwig (2005),

PROJECT IDENTITY 5
Roca (2006), and Baeriswyl and Cornand (2007) into the
general information precision choice model discussed above,
the authors find that the substitution elasticity between goods
induces a “taste” for coordination among agents. As a matter of
fact, the dispersion of prices induces scattering in the production
levels of individual goods; a phenomenon that reduces the
marginal utility of aggregate consumption. The optimal degree
of production coordination is larger than the privately
perceived one because individual price setters do not consider
that the dispersion of prices has a negative impact on the
allocation of resources. Accordingly, the optimal level of public
information precision is always positive and larger than the
socially optimal level of precision of privately acquired
information. This remains true even when it is assumed that
public information is substantially costlier than private
information. In a policy perspective, it is shown that the policy
maker should actively discourage individual agents from
collecting more precise private information. Indeed, the
introduction of a tax on the acquisition of private information
succeed in decreasing individual price dispersion, which is
optimal given the taste for individual actions alignment implied
by the monopolistic competition framework.

Key messages for
policy-makers,
businesses,
trade unions and
civil society actors
Essential references
PROJECT IDENTITY 6
The application of the authors' general framework to a model of
price setting with monopolistic competition highlights the
welfare enhancing role of public information provision.
Since price-setters aim at aligning their actions, the value they
attribute to their private signals is lower than the one they attach
to public information. Accordingly, the demand of private
information reduces the larger is the privately perceived motive
for coordination, which creates a need for public information
provision. As this need is reinforced by the fact that the “socially
optimal” degree of coordination is larger than the privately
perceived one, a public authority – e.g., a Central Bank –
should provide precise statistics of the key macroeconomic
variables. Furthermore, the provision of public information
tends to “crowd out” the acquisition of private information
because private agents obtain better information from a source
they value more. Accordingly, when public information is
optimally provided to firms, they have no incentives to acquire
private information. Hence, it is unlikely that the business cycle
will be driven, or amplified, by the dispersion of information. This
implies that active monetary or fiscal policies, as opposed to
information management, are the key ingredients for smoothing
the business cycle.
Angeletos, G. M., A. Pavan (2007), Efficient Use of
Information and Social Value of Information. Econometrica,
vol. 75, pp 1103-1142.
Baeriswyl, R., C. Cornand (2007), Can Opacity of a
Credible Central Bank Explain Excessive Inflation?.
Discussion paper 2007-08, University of Munich.
Hellwig, C. (2005), Heterogeneous Information and the
Welfare Effects of Public Information Disclosures. Mimeo,
UCLA.
Morris S., H. S. Shin (2002), The Social Value of Public
Information. American Economic Review, vol. 92, pp 1521-
1534.
Roca (2006) Transparency and Monetary Policy with
Imperfect Common Knowledge. Mimeo, Columbia
University.

PROJECT IDENTITY 7
Coordinator Prof. Domenico Delli Gatti (Catholic University, Milan)
Consortium Catholic University of Milan (Italy); University of Amsterdam (The
Netherlands); Università Politecnica delle Marche (Italy);
Fondation Nationale des Sciences Politiques (France); Catholic
University of Leuven (Belgium); University of Rome “La
Sapienza” (Italy).
Duration November 2008 – October 2011 (36 months)
Funding Scheme EC 7 th Framework Programme under Socio-economic Sciences
and Humanities, grant agreement n° 225408
Budget Total EC contribution Euro 1,331,530
Website www.polhia.eu
For more information info.polhia@unicatt.it