Moderating noise-driven macroeconomic fluctuations under dispersed information

Abstract

Can aggregate noise shocks produce large macroeconomic fluctuations, and if so, is there anything that policymakers can do about them? Yes and yes, if news about idiosyncratic fundamentals is contaminated by aggregate noise. I study a business cycle model where agents with rational expectations receive noisy signals about future productivity. The model features dispersed information, which allows aggregate noise shocks to produce frequent large fluctuations in the capital stock. Because of the information friction, a policymaker with an informational advantage can improve outcomes. I consider policies that affect investment incentives by distorting the intertemporal wedge. I calculate the optimal policy rule, and find that policymakers should discourage investment booms after aggregate news shocks.