Working Paper: CEPR ID: DP12656
Authors: Charles Brendon; Martin Ellison
Abstract: 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.
Keywords: time consistency; undominated policy; Ramsey policy
JEL Codes: D02; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| time-consistent policies (D15) | undominated policies (D72) |
| time-consistent policies (D15) | favorable efficiency-equity trade-off (D61) |
| Ramsey policies (H00) | undesirable long-term outcomes (I12) |
| multipliers under Ramsey policy (H00) | time inconsistency (D15) |
| time-consistently undominated policies (E61) | gradual decay in multipliers (C39) |
| time-consistently undominated policies (E61) | stable framework for decision-making (D70) |
| normative solution concept (D63) | viable alternative to Ramsey policy (H00) |