Imperfect information, multiple shocks, and policyʹs signaling role

In multiple shock models, when agents have imperfect information they attempt to infer a shockʹs type, in addition to its size. In this environment, monetary policy plays an important signaling role. This paper highlights this signaling role by showing that conclusions from imperfect information monetary models are sensitive to the number of shocks included. With multiple shocks, contractionary monetary policy can initially increase inflation and delay the eventual disinflation. Moreover, multiple shocks can result in destabilizing price flexibility, while optimal policyʹs response to one shock will depend on the existence of other shocks, contrary to a typical linear-quadratic framework.