DP17120 Time-consistent implementation in macroeconomic games

Author(s): Jean Barthelemy, Eric Mengus
Publication Date: March 2022
Keyword(s): Implementation, Limited Commitment, Policy Rules
JEL(s): C73, E58, E61, G28
Programme Areas: International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17120

Time-inconsistency may lead governments to face multiple equilibrium outcomes. In this paper, we determine the minimum cost that a government should incur when deviating from commitments -- e.g., through rules or delegations -- to implement a unique outcome. We show that a large cost is needed only when bold policy responses change private agents' actions -- e.g., due to bounded rationality -- or when the private sector can distort government's ex-post incentives -- e.g., through trigger strategies. Otherwise, a small cost of deviation is sufficient for the government to implement its desired outcome. We derive implications for models of bailouts, inflation bias, and capital taxation.