Rational Inattention to News: The Perils of Forward Guidance

This paper studies the social value of information about the future. In a stylized OLG model, agents need to forecast the future price level, they observe the current price and perceive with idiosyncratic noise the expectation announced by a more informed authority. When forward guidance communication is loose, the market becomes a main source of information about the future. Reliance on market information amplifies the impact of shocks on prices, which increases ex ante uncertainty and worsens agents' forecasting ability, harming social welfare. However, an appropriate policy can convert the perils of the announcement in opportunities. "Capacity-limited agents will act as if observing the state of the economy with error even if some public authority announces it exactly. The amount of the error will depend both on the stochastic properties of the state itself and of any noise in public signals about it.. issuing a much more detailed inflation report. the Fed would no longer be itself responsible for generating unnecessary market fluctuations." -Sims (2005)