The Social Cost of Heterogeneous Information∗

I study the welfare effects of a lack of common knowledge in a dynamic price-setting model with incomplete nominal adjustment due to incomplete, heterogeneous information. I identify two welfare effects of informational heterogeneity: First, it affects the dynamic adjustment of prices in response to aggregate shocks, and thereby the magnitude of aggregate consumption volatility. Second, informational heterogeneity leads to price dispersion across firms, which leads to an ex-post resource mis-allocation. There is a trade-off between the two: Better public information always improves the ex post resource allocation, but by acting as a focal point of beliefs, it may increase consumption and price volatility. Better private information reduces aggregate volatility, but may increase price dispersion. The aggregate welfare implications are driven by the latter: Better public information is always welfare-improving, but better private information may lead to welfare losses. Finally, I compare equilibrium strategies to the firstbest use of information, and show that the equilibrium relies too heavily on private information, relative to the social optimum. This inefficiency is the result of a forecasting externality, whereby individual decision rules do not internalize their effect on the forecasting problem other firms face in equilibrium.