Professional Documents
Culture Documents
American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The
American Economic Review.
http://www.jstor.org
1522
THEAMERICANECONOMICREVIEW
DECEMBER2002
(i) When the agents have no private information-so thatthe only source of information
for the agents is the public informationthen greater precision of the public information always increases social welfare.
(ii) However, if the agents have access to some
private information, it is not always the
case that greaterprecision of public information is desirable. Over some ranges, increased precision of public informationis
detrimental to welfare. Specifically, the
greaterthe precision of the agents' private
information, the more likely it is that increased provision of public information
lowers social welfare.
The detrimentaleffect of public information
arises from the fact that the coordinationmotive
entails placing too much weight on the public
signal relative to weights that would be used by
the social planner.The impact of public information is large, and so is the impact of any
noise in the public signal that inevitably creeps
in. In short, although public informationis extremely effective in influencing actions, the
dangerarises from the fact that it is too effective
at doing so. Agents overreactto public information, and thereby magnify the damage done by
any noise. Our objective is to show how such
"overreaction"need not be predicated on any
wishful thinking or irrationalityon the part of
agents.
The dilemmaposed by the potentialfor overreaction to public informationis a familiar one
to policy makers that command high visibility
in the market. Central bank officials have
learnedto be wary of public utterancesthatmay
unduly influence financial markets, and have
developed their own respective strategies for
communicatingwith the market.In formulating
their disclosure policies, centralbanks and governmentagencies face a numberof interrelated
issues concerning how much they should disclose, in what form, and how often. Frequent
and timely disseminationwould aid the decisionmaking process by putting currentinformation
at the disposal of all economic agents, but this
has to be set against the fact that provisional
estimates are likely to be revised with the benefit of hindsight. By their nature, economic
statistics are imperfect measurementsof sometimes imprecise concepts, and no government
VOL.92 NO. 5
1523
1524
THEAMERICANECONOMICREVIEW
propertiesof a rationalexpectationsequilibrium
in which the price serves as a public signal of
the distributionof costs among producers,and
show how this informationmay be detrimental
to welfare.
The "global games" literaturehas examined
the impact of public informationin binary action coordinationgames where agentshave both
private and public signals about some underlying state (see Morris and Shin, 1999, 2000;
ChristianHellwig, 2000; ChristinaMetz, 2000).
Here, if privateinformationis sufficientlyaccurate relative to public information, there is a
unique equilibriumin a setting where multiple
equilibriawould exist with common knowledge
of fundamentals.The comparativestatics of the
precision of public informationreveal complex
effects that arises from the interplay between
better fundamentals information and shifts in
strategic uncertainty.One virtue of the simple
model proposedin this paperis thatequilibrium
is unique irrespectiveof the parameters,so that
we are able to examine the impact of public
signals and obtain cleaner welfare implications.
The plan for the rest of the paper is as follows. We introduceour model in the next section, and solve for the unique equilibrium,
highlightingalong the way the distinctivechannels throughwhich public informationoperates.
The core of the paper is Section II, which examines the welfare effects of shifts in the precision of public information. A number of
extensions and variations of our model are
discussed in Section III, although the details
of these extensions are presented separatelyin
an Appendix,availableonline at the AEA web
The
site (http://www.aeaweb.org/aer/contents).
purposeof these extensions is both to demonstratethe robustnessof our main conclusions to
changes in the modeling assumptions,but also
to delve deeperinto the underlyingmechanisms
for the theoreticalresults. We conclude by pursuing some of the policy issues on disclosures
further.
DECEMBER2002
ui(a, 0)
-(1
0)2-
r)(ai-
r(Li-
L)
Li
0o
L-
Ljdj.
o
The loss function for individual i has two components.The first componentis a standardquadraticloss in the distancebetweenthe underlying
state 0 and his action ai. The second component
is the "beauty contest" term. The loss Li is
increasing in the average distance between i's
action and the action profile of the whole population. There is an externality in which an
individualtries to second-guess the decisions of
other individualsin the economy. The parameter r gives the weight on this second-guessing
motive. The larger is r, the more severe is the
externality. Moreover, this spillover effect is
socially inefficient in that it is of a zero-sum
nature. In the game of second-guessing, the
winnersgain at the expense of the losers. Social
welfare, defined as the (normalized)average of
individual utilities, is
r1
)
0)(a,
1 -r
u(a,
0) di
N0
(ai -
0)2 di
I. Model
Our model is based on a game that induces
strategic behavior in the spirit of the "beauty
contest" example mentioned in Keynes's General Theory (1936). There is a continuum of
VOL.92 NO. 5
(2)
ai = (1 - r)Ei(O) + rEi(a)
y=
+rl
where 7 is normallydistributed,independentof 0,
with mean zero and varianceo2&.
The signaly is
"public"in the sense thatthe actualrealizationof
y is commonknowledgeto all agents.Theychoose
their actions after observingthe realizationof y.
The expected payoff of agent i at the time of
decisionis thengivenby theconditional
expectation:
(4)
E(uily)
where E( * |y) is the common expectation operator. Conditional on y, both agents believe
that 0 is distributednormally with mean y and
variance o&2.Hence, the best reply of i is
(5)
E(ajly) dj
0)21 0]
-E[(y2
Xi =
0 +
ei
where noise terms si of the continuumpopulation are normally distributedwith zero mean
and varianceo<, independentof 0 and r1,so that
E(Sisj) = 0 for i : j. The privatesignal of one
agent is not observableby the others.This is the
sense in which these signals are private.
As before, the agents' decisions are made
after observing the respective realizations of
their privatesignals as well as the realizationof
the public signal. Denote by
(8)
ai(li)
the decisionby agent i as a functionof his informationset Ii. The informationset Ii consistsof the
pair(y, xi) thatcapturesall the informationavailable to i at the time of decision.3
Let us denote by a the precision of the public
information,and denote by j3 the precision of
the private information,where
ai(y) = (1 - r)E(Oly) + r
1525
(9)
1
2
77
' o
1
where ai(y) denotes the action taken by agent i
as a function of y. Since E(O0y) = y and since
the strategies of both agents are measurable
with respect to y, we have E(ajly) = aj(y), so
that in the unique equilibrium,
(6)
ai(y) = y
/~-
2.
3 The notation in
(8) makes explicit that the strategy of
agent i in the imperfect-informationgame is a function that
maps the information IJ to the action ai. For any given
strategy,ai is thereforea randomvariablethatis measurable
on the partitiongeneratedby Ii.
1526
THEAMERICANECONOMICREVIEW
Then, based on both private and public information, agent i's expected value of 0 is
K=
13(rK + 1 - r)
a+/3
ay + f3xi
(10)
a+/3
from
which we can solve for
where we have used the shorthandEi(') to denote the conditional expectationE( * |Ii).
C. Linear Equilibrium
(11)
Then agent i's conditionalestimate of the average expected action across all agents is
+
(ay ++
+ f /)
E^-a)=
= Kay
Ei(a)
-K)
-+ ((1-) K)y
Xi +
(21)
(1
a+1
+ rEi(a)
KB )
I
+t1-
(1 - r)Ei(O)
+ rEi(a).
K+B
I
Xi
+ 1 -
3(rK
a+X
a = (1 - r)Ei(0) + (1 - r)rEi(E(0))
+ (1 - r)r2E(E2())
r)
a+3
V[
r) + a
D. Uniquenessof Equilibrium
(14)
(3(rK + 1-
ay +3(l - r)Xi
,~a+/3(1-r)
(13)
ai=
+
=
( 1- r) ay
xiaya + px,\
+r
P(l
We will now solve for the unique equilibrium.We do this in two steps. We first solve for
a linearequilibriumin which actions are a linear
function of signals. We will follow this with a
demonstrationthat this linear equilibriumis the
unique equilibrium.Thus, as the first step, suppose that the populationas a whole is following
a linear strategyof the form
ai(i)
DECEMBER2002
r))
(1 - r) E
y.
+ ...
rkEi(Ek(0)).
k=O
VOL
92NO.
5 AND SHIN: SOCIALVALUEOF PUBLIC INFORMATION
MORRIS
VOL 92 NO. 5
and
? /3xi
E =ay
0
a+ f3
thleaverageexpectationof 0 acrossagentsis
Thbus,
+f3O
~~ay
E(0)
Ei(0)di
1-gk?l)y
+ f3xi)
ayky
k~(E()) =(1
(15)
1527
12
ijk+l1Xi
a=
a=
(1
r) I
rk[(l
tLk?l)y
,llk+lXi]
k =O
Ei (E(0))=Eik
(ay
a+ 3
g(l
r) y +
I
rg
g(l
r)
I - rg
Xi
ay + 131-r)xi
a?f3(1r)
ay+ 0 a(yf3
i)
we identified earlier.
_((a
+f32X~
+f3)2-f2)y
+1)
-(a
E(E(O))
ys=b[ai-Eia]
+f320
_((a +(3)2-(32)y
(a
?13)
gkOadE-k(o))
where ji
k+1)
k
(1
)+
?~k+
c[Ei(6) -ai]
f31(a + 13).
PROOF:
The proof is by induction on k. We know
from (15) that the lemma holds for k = 1.
Suppose that it holds for k - 1. Then,
-(k l(O))
=(1
so
Ek(0)
(1 -
(1
r)Ej(0) ? rEi(ai)
11~k)y+ p.kXi
gk)y ? W o
THEAMERICANECONOMICREVIEW
1528
(ai
0)2 di
DECEMBER2002
ai = 0 +
a+
(-r)
3(l - r)
(1 - r)2
+
3(1
-r)]2
[a
By examining (17), we can answer the comparative statics questions concerning the effect of
VOL.92 NO. 5
1529
aE(WI0)
,\
We \(Wl)
ine
+ r)a + ( - r)2j3]
>
+
3(1 -r)]3
[a
(1 - r)[(l
(19)
(1 - r)]3
so that
aE(WI0)
aa
doe
(20)
if and only if
(
a-
1
(2r-
1)(1 - r)
When r > 0.5, there are ranges of the parameters where increasedprecision of public information is detrimental to welfare. Increased
precision of public information is beneficial
only when the privateinformationof the agents
is not very precise. If the agents have access to
very precise information(so that , is high), then
any increase in the precision of the public information will be harmful. Thus, as a rule of
thumb, when the private sector agents are already very well informed, the official sector
would be well advised not to make public any
more information,unless they could be confident thatthey can provide public informationof
very great precision. If a social planner were
choosing ex ante the optimalprecision of public
informationand increasingthe precisionof public informationis costly, then corer solutions at
a = 0 may be common.
aCE
FIGURE1. SOCIALWELFARECONTOURS
ai=
ay + 3(1 - r)xi
(-r)
a
(1-r)
ay + 3xi
a+/3
+ (y - xi)
Pr
( c +
a + ((1
- r)'
THEAMERICANECONOMICREVIEW
1530
(22)
Ei(O).
Ei(E(O)) -
These propertiesare key,_sinceif we had equality between E(0) and E(E(0)) and between
Ei(E(O)) and E(0) then all higher-order-level
expectations collapse to the first order, so that
(14) would become
oc
E,(E(0))(1
- r) E
rk= Ei(E(0))
k=O
= Ei(0)
which coincides with the socially efficient action. Thus, it is this failureof the law of iterated
expectations for the expectationsoperatorsthat
injects genuine strategic uncertainty into the
problem, and which entails the overreactionto
public information.The importance of shared
knowledge in the promulgationof policy was
emphasized by Phelps in his 1983 paper, and
our results could be seen as giving this assertion formal backing. More recently, Woodford (2001) has argued that the persistence
exhibited by many macroeconomic time series can be explained by the relative inertia of
higher-orderbeliefs as compared to first-order
DECEMBER2002
Ei(0)-
pE,(a)
VOL.92 NO. 5
ai
l+
/(1
p
+ p)
a + p3(1 + p) Xi
a
The symmetric-informationbenchmarksolution
is when ai = aj for all i, j which gives ai =
Ei(a), so that
(24)
ai =1
(a1 -
0)2 + (a2
(/3xi+ay)
ai = KXi + (1 -
aj-
( + p) y
+ a +
1531
0)2 + 2q(al
0)(a2
K)y
xj+
K)y -
j=l
_(
=-E
> Ln
-
E j + (1-
K)
j=l
0).
In otherwords,the loss is increasingin the product of the two errors.This gives rise to strategic
betweenthe two teammembers,so
substitutability
that the optimaldecisions put less weight on the
publicinformationandmoreweighton the private
informationas comparedto the individualdecision. The choice of output in a Courot model
examined by Robert M. Townsend (1978) also
falls into this categoryof strategicsubstitutes.
As well as alternativepayoff functionsfor the
individualplayers, we could also consider alternative forms of the welfare function. For instance, if we pursue our macroeconomic
interpretationof the model as the interaction
between a central bank and the private sector
agents, one naturalway to formulate the principal's objective function is in terms of the
5
We are grateful to Takashi Ui for this reference. Ui
(2001) shows thatRadner'smodel as well as our own model
here can be analyzed as Bayesian potential games.
(1 -
K2
n/3
The value of
loss is
K)2
no
a + 3np'
1532
THEAMERICANECONOMICREVIEW
simplistic in the way that it exploits the independently and identically distributed(i.i.d.) natureof noise terms.More realistically,we might
expect that private signals have sharedraw ingredientsacross the populationthatimpartcomplex correlation structures across private
signals. As a simple example, private signals
that have the structure xi = 0 + ~ + ei, where
DECEMBER2002
VOL. 92 NO. 5
1533
REFERENCES
Azariadis, Costas. "Self-Fulfilling Prophesies."
Journal of Economic Theory, December
1981, 25(3), pp. 380-96.
Banerjee,Abhijit V. "A Simple Model of Herd
Behavior." QuarterlyJournal of Economics,
August 1992, 107(3), pp. 797-817.
Basel Committeeon Banking Supervision.Recommendationsfor public disclosure of trading and derivatives activities of banks and
securitiesfirms. Basel: Bank for International
Settlements, 1999a.
. A new capital adequacy framework.
Basel CommitteePublicationsNo. 50. Basel:
Bank for International Settlements, 1999b
(http://www.bis.org/publ/bcbs50.pdf).
Bikhchandani, Sushil; Hirshleifer, David and
Welch,Ivo. "A Theoryof Fads, Fashion,Custom, and Cultural Change in Informational
Cascades." Journal of Political Economy,
October 1992, 100(5), pp. 992-1026.
Blinder, Alan. Central banking in theory and
practice. Cambridge, MA: MIT Press,
1998.
Blinder, Alan; Goodhart, Charles; Hildebrand,
Philipp;Lipton,David and Wyplosz,Charles.
How do central banks talk? Geneva Report
on the World Economy 3, Centre for Economic Policy Research, London, 2001.
Cao, H. Henry and Hirshleifer,David. "Conversation, ObservationalLearningand Informational Cascades"WorkingPaperNo. 2001-5,
Ohio State University, 2000.
Cass, David and Shell, Karl. "Do Sunspots Matter?" Journal of Political Economy, April
1983, 91(2), pp. 193-227.
Chwe,MichaelS. Y. Rationalritual:Culture,coordination,and commonknowledge.Princeton,
NJ: PrincetonUniversityPress, 2001.
Hellwig,Christian."Public Informationand the
Multiplicity of Equilibria in Coordination
Games." Working paper, London School of
Economics, 2000.
Hirshleifer,Jack. "ThePrivateand Social Value
of Informationand the Reward to Inventive
Activity." American Economic Review, September 1971, 61(4), pp. 561-74.
(http://www.imf.org/external/np/
omd/100198.htm).
Jevons,William.Investigationsin currency and
finance. London: Macmillan, 1884.
Keynes, John Maynard. The general theory of
employment, interest, and money. London:
Macmillan, 1936.
Krugman,Paul. "Out of the Loop." New York
Times, March 4, 2001, Sec. 4, p. 15.
Lucas, Robert E., Jr. "Expectations and the Neu-
tralityof Money." Journal of Economic Theory, April 1972, 4(2), pp. 103-24.
. "Some International Evidence on
Output-Inflation Tradeoffs." American
Economic Review, June 1973, 63(3), pp.
326-34.
1534
THEAMERICANJEC(3NOMICREVIEW
Raith, Michael."A General Model of Information Sharing in Oligopoly." Journal of Economic Theory,October1996, 71(1), pp. 26088.
Samet, Dov. "IteratedExpectations and Common Priors."Games and EconomicBehavior,
July-August 1998, 24(1-2), pp. 131-41.
Shiller, Robert. Irrational exuberance. Princeton, NJ: PrincetonUniversity Press, 2000.
Spanos, Aris. Statisticalfoundations of econometric modelling. Cambridge: Cambridge
University Press, 1986.
Teoh, Siew Hong. "InformationDisclosure and
Voluntary Contributionsto Public Goods."
RANDJournal of Economics, Autumn 1997,
28(3), pp. 385-406.
DECEMBER2002