Business Cycle Fluctuations and Monetary Policy under Heterogeneous Information

Modeling business cycle fluctuations and the non-neutrality of money is an ongoing challenge for macroeconomists. This chapter illustrates how higher-order beliefs lead to an overreaction to public information, a mechanism that was introduced by Morris and Shin. It provides technical details to solve a simple class of models based on beauty-contest games. The chapter relates to monetary non-neutrality under heterogeneous information and explains how Woodford initiated the revival of the heterogeneous-information hypothesis by adding strategic complementarities to the model of Lucas. It further discusses the contribution of Mackowiak and Wiederholt and Pasten and Schoenle in rationalizing the limited attention that firms pay to economic shocks. The chapter explains how dispersed information impinges on the transmission of real shocks and business cycle fluctuations. It deals with communication and stabilization policies.