DP12656 Time-Consistently Undominated Policies

Author(s):	Charles Brendon, Martin Ellison
Publication Date:	January 2018
Keyword(s):	Ramsey Policy, Time Consistency, Undominated Policy
JEL(s):	D02, E61
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=12656

This paper proposes and characterises a new normative solution concept for Kydland and Prescott problems, allowing for a commitment device. A policy choice is dominated if either (a) an alternative exists that is superior to it in a time-consistent subdomain of the constraint set, or (b) an alternative exists that Pareto-dominates it over time. Policies may be time-consistently undominated where time-consistent optimality is not possible. We derive necessary and sufficient conditions for this to be true, and show that these are equivalent to a straightforward but significant change to the first-order conditions that apply under Ramsey policy. Time-consistently undominated policies are an order of magnitude simpler than Ramsey choice, whilst retaining normative appeal. This is illustrated across a range of examples.