DP13403 Organizational Equilibrium with Capital

Author(s): Marco Bassetto, Zhen Huo, José-Víctor Ríos-Rull
Publication Date: December 2018
Date Revised: December 2018
Keyword(s): Capital-Income Taxation, Quasi-Geometric Discounting, Renegotiation, reputation, Time Inconsistency
JEL(s): C73, E61, E62
Programme Areas: Public Economics, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13403

This paper proposes a new equilibrium concept - organizational equilibrium - for models with state variables that have a time-inconsistency problem. The key elements of this equilibrium concept are: (1) agents are allowed to ignore the history and restart the equilibrium; (2) agents can wait for future agents to start the equilibrium. We apply this equilibrium concept to a quasi-geometric discounting growth model and to a problem of optimal dynamic fiscal policy. We find that the allocation gradually transits from that implied by its Markov perfect equilibrium towards that implied by the solution under commitment, but stopping short of the Ramsey outcome. The feature that the time inconsistency problem is resolved slowly over time rationalizes the notion that good will is valuable but has to be built gradually.