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Transparency of Information and Coordination in Economies with Investment Complementarities

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Transparency of Information and Coordination in Economies with Investment Complementarities ISSUES IN MACROECONOMIC POLICY DESIGN Transparency of Information and Coordination in Economies with Investment Complementarities By GEORGE-MARIOS ANGELETOS AND ALESSANDRO PAVAN* Economies with production externalities, de- spect to public information, which increases the mand spillovers, incomplete financial markets, volatility generated by common noise in market and Keynesian frictions are only a few exam- expectations. Moreover, when information is ples of those in which macroeconomic comple- heterogeneous, an increase in the precision of mentarities play a prominent role. Within this public information may have the perverse effect class of economies, how does the precision of of increasing aggregate volatility, by increasing publicly provided and privately collected infor- the sensitivity of economic activity to common mation affect equilibrium allocations and social noise. On the contrary, an increase in the pre- welfare? And what is the optimal transparency cision of private information necessarily re- in the information conveyed, for example, by duces aggregate volatility. Nevertheless, we economic statistics, policy announcements, or show that, as long as there is no value to lotter- news in the media? To answer these questions, ies, welfare unambiguously increases with an we consider a simple real economy where the increase in either the relative or the absolute individual return to investment is increasing in precision of public information. Hence, policies the aggregate level of investment and where that either disseminate more precise informa- market participants have heterogenous expecta- tion about economic fundamentals or reduce the tions about the underlying economic fundamen- heterogeneous interpretation of economic statis- tals (the exogenous productivity). We interpret tics and policy measures necessarily boost wel- an increase in the transparency of public infor- fare. On the contrary, an increase in the mation either as a reduction in the level of precision of private information may reduce common uncertainty for a given level of idio- welfare by increasing the heterogeneity of ex- syncratic uncertainty (that is, an increase in the pectations and thereby obstructing coordination absolute precision of public information) or as a in the market, in which case policies that dis- reduction in the heterogeneity of expectations courage the private collection of private infor- across market participants for a given level of mation may increase welfare. overall uncertainty (that is, an increase in the Morris and Shin (2002) argued that, in envi- relative precision of public information). ronments with strategic complementarities and We first consider an environment where heterogeneous information, more precise public complementarities are weak, so that the equilib- information can reduce social welfare, whereas rium is unique no matter the structure of infor- more precise private information is always ben- mation. As in Stephen Morris and Hyun Song eficial. We find rather the opposite. The differ- Shin (2002), complementarities increase the ence in the results is due to an important sensitivity of equilibrium allocations with re- distinction between the environments in the two models. Morris and Shin (2002) consider a kind of “beauty contest,” where the payoff of a * Angeletos: Department of Economics, Massachusetts player decreases with the distance between his Institute of Technology, 50 Memorial Drive, E52-251, Cambridge, MA 02142, and NBER (e-mail: angelet@ own action and the action of others, but where mit.edu); Pavan: Department of Economics, Northwestern this distance is irrelevant from a social perspec- University, 2001 Sheridan Road, Andersen Hall Room tive. It follows that the complementarity is 3239, Evanston, IL 60208-2600 (e-mail: alepavan@ present only at the private level, and hence the northwestern.edu). We are grateful to Narayana Kocherla- kota for the invitation to prepare this paper. For useful attempt of the agents to align their actions is comments, we thank Daron Acemoglu, Ricardo Caballero, socially wasteful. In this case, more transparent Christian Hellwig, Bengt Holmstrom, and Ivan Werning. public information facilitates more effective 91 92 AEA PAPERS AND PROCEEDINGS MAY 2004 coordination, which is valued by the market but policy traps, where the optimal policy and not by society. In contrast, we consider envi- market outcomes are dictated largely by arbi- ronments where the complementarity is present trary self-fulfilling market expectations. In at the social level so that effective market co- the present paper, we do not consider active ordination is socially valuable, as is likely to be policy intervention. Nevertheless, a similar trap the case in economies with production and de- emerges regarding the information dissemi- mand spillovers, network externalities, or in- nated by government agencies and central complete financial markets. As shown in bankers: The optimal transparency depends Angeletos and Pavan (2003), market partici- on the aggressiveness or leniency of market pants use public information to align their in- expectations. vestment choices, but not enough as compared We conclude that, in the class of environ- to what is socially optimal, for they do not ments considered in this paper, noise in public internalize the positive externality of their in- information may be socially desirable only vestment on the return to others. As a conse- when there is a high risk that more transparency quence, more transparent public information, by will introduce coordination failures.2 Other- permitting more effective coordination in the wise, the timely and frequent provision of pub- market, necessarily increases welfare, despite lic information seems warranted from a social the fact that it may lead to higher volatility.1 perspective, even if that may lead to an increase In light of these results, we finally consider in volatility. the possibility that complementarities are strong enough that multiple equilibria emerge for cer- I. Weak Complementarities tain structures of information, in which case more effective coordination in the market need Preferences and Technologies.—The econ- not always be socially beneficial. Indeed, there omy is populated by a (measure 1) continuum of is a critical threshold for the transparency of agents, indexed by i and uniformly distributed public information above which multiple equi- over the [0, 1] interval. Agents are risk-neutral librium levels of investment are possible. with utility Above this threshold, the desirability of more ϭ Ϫ 1 2 effective market coordination and thus the wel- (1) ui Aki ki . fare effect of more transparent public informa- 2 ʦ ޒ tion depend critically on which equilibrium is We interpret ki as individual investment (or 2 selected. If the market coordinates on the so- effort), A as the return to investment, and ki /2 ϭ͐1 cially desirable equilibrium, facilitating coordi- as the cost of investment. We let K 0 ki di nation is beneficial, and welfare tends to be denote the aggregate level of investment. maximized at high levels of transparency. If Like John Bryant (1983), Russell Cooper and instead the market coordinates on the undesir- Andrew John (1988), Daron Acemoglu (1993), able equilibrium, impeding coordination by in- Jess Benhabib and Roger Farmer (1994), and troducing noise in public information can be others, we introduce a complementarity by as- welfare-enhancing. suming that the individual return to invest- This final result is related to Angeletos et al. ment is increasing in the aggregate level of (2003), where it is shown that, in coordination investment: environments where a privately informed poli- cymaker is interested in fashioning market out- (2) A ϭ ͑1 Ϫ ␣͒␪ ϩ ␣K. comes, active policy intervention may lead to The random variable ␪ parameterizes the exog- 1 In independent parallel work, Christian Hellwig (2003) and Guido Lorenzoni (2003), building on Michael Wood- 2 Matthew Canzoneri (1985), Alex Cukierman and Allan ford (2003), examine monetary economies in which Meltzer (1986), Andrew Atkeson and Patrick Kehoe (2001), complementarities arise in pricing decisions. They also find Nancy Stokey (2003), and others consider how the trans- that the Morris-Shin result about the social value of public parency of policy instruments relates to the ability of the information can be reversed. However, they do not show market to detect policy deviations in Barro-Gordon envi- how the welfare effects of public information depend on ronments where the government lacks commitment. Our whether market coordination is socially desirable. approach is clearly orthogonal to that line of research. VOL. 94 NO. 2 ISSUES IN MACROECONOMIC POLICY DESIGN 93 enous return to investment (the underlying fun- ever, xi introduces idiosyncratic variation in damentals of the economy) and the coefficient market expectations about the fundamentals and ␣ Ն 0 captures the degree of complementarity. may thus be read also as heterogeneity in the Finally, social welfare is given by a utilitarian filtering and interpretation of commonly avail- ϭ͐1 ␦ aggregator, w 0 ui di. Using (1) and (2), we able information. In this sense, measures the have that level of conformity in market expectations, whereas ␴ measures the quality of available 1 information. w ϭ AK Ϫ 1 ͵ k2 di In the following, we interpret an increase in 2 i the transparency of public information either as 0 ␴ ␴ a reduction in z for given x (that is, an in- crease in the absolute precision of public
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