DP536 Which `Simple' Rules Rather than Discretion?
|Author(s):||Daniel Cohen, Philippe Michel|
|Publication Date:||March 1991|
|Keyword(s):||Credibility, Macroeconomic Policy, Time Inconsistency|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=536|
The dynamic inconsistency of a government's preferred policy, when it occurs, usually implies that the maximum level of welfare that can be delivered at some initial time can only be attained by constraining the economy to `low' levels in the future. In this paper, we set up a linear quadratic model in which the `best' policy rule which is looked for today is subject to the constraint of always delivering in the future a given reservation level of welfare which in equilibrium is the level that the `best' policy itself offers to deliver. We fully characterize the solutions to this problem in the cases when the government policies are constant, linear and kinked linear.