Collaborative Research on Adjustment Costs and Information in Aggregate Fluctuations

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This project studies the aggregate consequences of the interaction between the adjustment costs faced by individual agents and the transmission of information in the economy. Adjustment costs provide a natural reason for information to be imperfect in a multi-agent economy. When action is costly, individuals will not find it in their interests to respond to every change in their circumstances, thereby preventing the transmission of individually held information to others through market data. In turn, the information problem creates a reason why, even in a competitive setting, equilibrium may be suboptimal. When individuals weigh the costs and benefits of action, they ignore the value to others of the information revealed by their action. The goal of this study is to show that the extent of our ignorance can play a key role in determining both the average level of business activity and the pattern of fluctuations. To accomplish this task many difficult modelling problems, such as aggregation in the face of adjustment costs and the partial revelation of information in general equilibrium models, must be solved. A preliminary theoretical model which overcomes many of the difficult modelling problems and allows a complete analysis of the steady state interactions between information and adjustment costs was completed. Non-steady state extensions in which the importance of information dynamics is readily appreciated will be developed. The idea that information may only be released through action and that adjustment costs limit action has important consequences for economic fluctuations. In particular, the interaction of information and adjustment costs may result in the bunching of individual decisions. The failure of others to act may lead all agents to hesitate, while action by others may promote responses. This may lead to increased market volatility. This study takes us down the path to a better understanding of possible causes and consequences of incomplete information on the behavior of the economy.