Credibility and time consistency in a stochastic world (Q1092789)
From MaRDI portal
scientific article
Language | Label | Description | Also known as |
---|---|---|---|
English | Credibility and time consistency in a stochastic world |
scientific article |
Statements
Credibility and time consistency in a stochastic world (English)
0 references
1987
0 references
This paper reexamines the issue of the credibility and sustainability of optimal policies derived from Pontryagin's Maximum Principle and generally regarded as time-inconsistent, in models with forward-looking rational expectations. Specifically, it considers the behaviour of such models in the presence of continuing stochastic noise. This is shown to convert the policy problem from a one-shot dynamic policy game to a continuing game, giving governments an incentive to invest in a reputation for not reneging on the full optimal rule. This incentive may, in certain circumstances, render the full optimal rule credible and therefore sustainable. It is demonstrated that a sufficiently low degree of discounting on the part of government, or a sufficiently high variance of shocks (measured relative to the initial diplacement) ensures the sustainability of the full optimal rule. Using a simple dynamic open economy model, these conditions are shown to be plausible unless the discount rate is very high.
0 references
time inconsistency
0 references
credibility
0 references
sustainability of optimal policies
0 references
Pontryagin's Maximum Principle
0 references
rational expectations
0 references
continuing game
0 references
dynamic open economy
0 references