We study how volatility in monetary policy affects economic performance in
the presence of asymmetric information and endogenously chosen information
structures. We consider a model in which in the absence of either feature t
he equilibria would be efficient. The equilibria that we find are inefficie
nt for two reasons: first, in some cases, agents fail to trade, even though
it is efficient to do so; second, agents spend resources acquiring sociall
y useless information. The model predicts a nonlinear relationship between
inflation and output and a complex pattern of price dispersion, with the na
ture of the relationship changing with the degree of volatility. (C) 2001 A
cademic Press.