Indicator variables for optimal policy under asymmetric information

The optimal weights on indicators in models with partial information about the state of the economy and forward-looking variables are derived and interpreted, both for equilibria under discretion and under commitment. The private sector is assumed to have more information than the policymaker. Certainty equivalence holds for the optimal reaction function in state-space form, but not for the reaction function in integrative form. Furthermore, the usual separation principle does not hold, as estimation of the state of the economy is not independent of optimization. We provide a general characterization of optimal filtering and control for these settings. (C) 2003 Elsevier B.V. All rights reserved.