Working Paper: NBER ID: w12076
Authors: Robert G. King
Abstract: Discretionary policymaking can foster strategic complementarities between private sector decisions, thus leading to multiple equilibria. This article studies a simple example, originating with Kydland and Prescott, of a government which must decide whether to build a dam to prevent adverse effects on floods on the incomes of residents of a floodplain. In this example, it is socially inefficient to build the dam and for people to live on the floodplain, with this outcome being the unique equilibrium under policy commitment. Under discretion, there are two equilibria. First, if agents believe that few of their fellow citizens will move to the floodplain, then they know that the government will choose not to build the dam and there is therefore no incentive for any individual to locate on the floodplain. Second, if agents believe that there will be many floodplain residents, then they know that the government will choose to build the dam and even small benefits of living on the floodplain will lead them to choose that location. In this second equilibrium, all individuals are worse off.
Keywords: No keywords provided
JEL Codes: E5; E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| discretionary policymaking (E60) | emergence of multiple equilibria (C62) |
| policy commitment (E60) | unique equilibrium is socially efficient (D50) |
| discretionary policymaking (E60) | socially inefficient outcome (D61) |
| strategic complementarities (D10) | emergence of multiple equilibria (C62) |
| expectations of the private sector (E69) | discretionary policymaking (E60) |