Policy Announcements and Welfare

We show that in the presence of idiosyncratic risk, the public revelation of information about risky aggregate outcomes such as policy choices can have a welfare-reducing effect. By announcing information on non-insurable aggregate risk, the policy maker distorts households’ incentives for insurance of idiosyncratic risk and increases the riskiness of the optimal self-enforceable allocation. The negative effect of distorted insurance incentives can be quantitatively important for a monetary authority that reveals changes in its short-run inflation target. We characterise parameters for which the effect dominates conventional effects that favour releasing better information.