Essays on Information in Macroeconomics and Finance
Expectations formation is central to macroeconomics. Households, firms, and policymakers must form expectations not only about fundamentals, but about what other agents’ beliefs are, because others’ beliefs will determine their actions. The three essays in this dissertation examine empirically and theoretically how agents use both public and private information to form expectations. The first two essays combine a models of optimizing behavior and forecasting with data on the macroeconomy, financial prices, and macroeconomic forecasts to examine the extent to which economic agents learn about the macroeconomy from financial prices and monetary policy actions. The third essay examines theoretically how members of a committee use public and private information to form beliefs when they care both about having accurate forecasts and coordinating actions with others. All three essays emphasize that frictions in expectations formation are a salient feature of the world, and understanding the extent and importance of those frictions is important for both positive and normative questions in macroeconomics and finance. Beliefs about the future determine the willingness of financial market participants to save and invest, and theory suggests they should value more highly assets which are expected to pay higher returns during recessionary periods when consumption is otherwise low. Hence, financial prices reflect macroeconomic expectations. In the first essay, titled "Macroeconomic Disagreement in Treasury Yields," I explore how agents with idiosyncratic, private information form beliefs about both the macroeconomy and the beliefs of other agents. Using data on United States Treasury debt, the macroeconomy, and individual inflation forecasts, I estimate the precision of bond traders’ information about the macroeconomy and how much they disagree with each other. I allow for traders to learn both from private signals and from asset prices, which aggregate the beliefs of all the traders in the market. I find that bond prices are moderately informative about macroeconomic variables, but are the source of most of the information traders have about monetary policy and the beliefs of others. In contrast to studies which assume full information, risk premia are much less important than slow-adjusting interest rate expectations for explaining the behavior of long-run yields. The most important signal for bond traders appears to be the Federal Reserve’s short-run rate, which encodes information about the macroeconomy and the central bank’s intended future policy. Nevertheless, the fact that traders held disparate beliefs about the macroeconomy, and especially about the long-run inflation target of the Federal Reserve, elevated long-term yields on average. The first essay demonstrates empirically that financial market participants learn about the macroeconomy from monetary policy actions. However, it is silent on how monetary policymakers form beliefs about the macroeconomy, or how the information in monetary policy rates endogenously affects macroeconomic outcomes. In the second essay "Your Guess is as Good as Mine: Central Bank Information and Monetary Policy," I use data on private sector forecasts and forecasts from the Federal Reserve Board staff to examine the typical assumption of common information between firms and monetary policymakers. Using forecasts from a survey of professional forecasters and from the Federal Reserve Board staff, I show evidence against the typical assumption of common information between monetary policymakers and the private sector, and also that policymakers are, at best, only weakly better at forecasting than private forecasters. Based on this evidence, I augment an otherwise standard monetary policy model by relaxing the common information assumption. Instead, I assume there is idiosyncratic, private information among price-setting firms, and between firms and the central banker. Firms combine private information about aggregate conditions with the observed monetary policy rate to form expectations about fundamentals and the beliefs of rival firms. The central banker must form expectations about firms’ beliefs because those beliefs will determine inflation and overall economic activity. But as a result of their differences in information sets, firms must form expectations about other firms’ expectations, and what the central banks’ expectations of their expectations are. I examine the ability of this model to fit the data and find that the model can capture features of both firm and central bank inflation expectations, but in the absence of imperfect information among households, it is difficult to simultaneously match the forecast data and data on real activity. This result points to the sensitivity of models with dispersed information to the underlying assumptions about how central bankers will respond to exogenous shocks. The second chapter emphasized how the assumptions economists make regarding monetary policymakers’ information is critical for understanding their actions. Motivated by this example, my third chapter "Information Investment in a Coordination Game" explores theoretically how members of a committee who are uncertain about others’ beliefs decide on a binary action, and how their decision to pay close attention to public or private signals is related to their desire to accurately forecast versus coordinating their behavior with others. I show that when it is assumed that information decisions among committee members are symmetric - everyone pays the same amount of attention to the same things - there is a unique outcome of the coordination game. However, I further show that it is difficult to guarantee that committee members will all choose a symmetric allocation of information. Aside from the direct cost of acquiring better information, allocating attention to more accurate signals can harm welfare when coordination motives are dominant. In a set of numerical exercises, however, I show that it is possible for a unique equilibrium to exist, and that actions that do not have a large impact on the payoffs of committee members (such as changing the size of the committee) may nevertheless have large impacts on the accuracy of the committee’s forecasts. This suggests a possible tension between the welfare of the committee, which benefits from consensus, and the welfare of those affected by the committee’s actions, which likely depends on whether the committee takes the objectively correct action. My dissertation has important implications for both academic economists and policymakers. Understanding the sources of business cycle fluctuations and the determinants of asset prices requires grappling with the fact that people have differences in beliefs. Empirical evidence suggests that agents’ beliefs are shaped by both idiosyncratic forces and by public announcements and policy decisions, and economists’ models need to reflect these features of the world. Policy, too, is affected by the information available to policymakers, and to understand how policymakers have acted in the past and should act in the future, it is necessary to take seriously the ways their belief formation deviates from the full information rational expectations benchmark.