Working Paper: NBER ID: w24496
Authors: Marina Halac; Pierre Yared
Abstract: We develop a simple model to study rules based on instruments vs. targets. A principal faces a better informed but biased agent and relies on joint punishments as incentives. Instrument-based rules condition incentives on the agent's observable action; target-based rules condition incentives on outcomes that depend on the agent's action and private information. In each class, an optimal rule takes a threshold form and imposes the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the agent's information is sufficiently precise. An optimal unconstrained rule relaxes the instrument threshold whenever the target threshold is satisfied.
Keywords: Instrument-based rules; Target-based rules; Monetary policy; Fiscal policy; Welfare
JEL Codes: D02; D82; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| precision of the agent's information (D82) | effectiveness of the rule class (C52) |
| target-based rules dominate instrument-based rules if the agent's information is sufficiently precise (D82) | principal's welfare (I39) |
| optimal hybrid rule (C61) | improved welfare outcomes (I38) |
| agent's bias (L85) | effectiveness of the rules (L15) |
| severity of punishment (K40) | effectiveness of the rules (L15) |