Discussion paper

DP12656 Time-Consistently Undominated Policies

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.

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Citation

Brendon, C and M Ellison (2018), ‘DP12656 Time-Consistently Undominated Policies‘, CEPR Discussion Paper No. 12656. CEPR Press, Paris & London. https://cepr.org/publications/dp12656