Economics
Time-inconsistency Problem
The time-inconsistency problem refers to a situation where a decision maker's preferences change over time, leading to inconsistent choices. In economics, this can create challenges for policymakers when trying to implement long-term policies, as individuals may change their behavior in response to short-term incentives. This can lead to suboptimal outcomes and inefficiencies in the economy.
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5 Key excerpts on "Time-inconsistency Problem"
eBook - PDF- S.G. Hall, S.G.B. Henry(Authors)
- 2014(Publication Date)
- North Holland(Publisher)
354 S.G. Hall and S.G.B Henry inconsistency using a version of the National Institute macro econometric model. As the model is non-linear, the analysis in this latter passage is entirely numerical, but is an important addition to the theoretical discussion of the earlier sections, in that it utilises an econometric model. The material is organised as follows. The next two sections are devoted to an introductory account of concepts used in the time-inconsistency debate. Section 4 then widens the class of models to incorporate a more familiar intertemporal optimal control form of policy design. Section 5 is then largely concerned with the non-linear econometric example. 2 . Game theory; some basic concepts The time inconsistency literature is a particular application of game theory. As such, many of the basic concepts used are best explained in a more general framework, and in this section we will give a brief account of the main ideas behind game theory. A more complete exposition may be found in Intriligator (1971). Two primary sources of particular importance are Luce and Raiffa (1957) and von Neumann and Morgenstern (1947). In the discussion of control theory and optimisation in chapter 7, the implicit assumption was made that there was one decision maker whose preferences were represented by the objective function, and that the economy generally could be viewed as a purely mechanical set of Ch. 8: Time Inconsistency 355 constraints. This description is, in fact, a rather poor representation of economic behaviour since many decision makers are involved in most economic activities, and the objectives of the decision makers will generally conflict to a greater or lesser extent. Game theory is the extension of conventional optimisation theory to the case of multiple decision makers.
eBook - PDFMonetary Economics
Policy and its Theoretical Basis
- Keith Bain, Peter Howells(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
This might make their policy statements credible in the view of market agents. This is related to the notions of time consistency and inconsistency. Kydland and Prescott intro-duced these terms in 1977, although the ideas behind them are not new. A time con-sistent equilibrium is another version of long-run equilibrium. A time inconsistent equilibrium is one that, for one reason or another, cannot be sustained. In Kydland and Prescott’s model, the policymaker is engaged in a strategic dynamic game over a period with sophisticated forward-looking private sector agents (agents who employ rational expectations). They argue that, in such cir-cumstances, ‘...discretionary policy, namely the selection of that decision which is best, given the current situation, does not result in the social objective function being maximised’ (Kydland and Prescott, 1977, p.463). What this means is that if a government formulates and announces an optimal policy and private agents believe this, in subsequent periods the policy may not remain optimal. This is because, in the new situation, the government has an incentive to renege on the previously announced optimal policy. This change in the optimal policy over time is known as time inconsistency. More formally, the optimal policy comput-ed at time t is time-inconsistent if re-optimization at time t+n produces a differ-ent optimal policy. The fact that policies may be time-inconsistent significantly weakens the credibility of policy announcements by the authorities since market agents are always aware that the authorities might not carry out the promises made in the first period. The optimal design of monetary policy 248 Kydland and Prescott employ the New Classical version of the Phillips curve to illustrate this view that discretionary policies are incapable of achieving an optimal equilibrium.
eBook - PDF- Allan Drazen(Author)
- 2018(Publication Date)
- Princeton University Press(Publisher)
In Chapter 5, where we consider institutional solutions to the time-consistency problem, this stochastic element introduces an important . trade-off. If a potential time-consistency problem arises in an environ- ment with no uncertainty, or in one where all contingencies can be fully specified ex ante, committing the policymaker to a course of action Ž . defined to include fully specified state-contingent action may well be optimal. In the real world, however, unforseen and unforecastable events occur, so that the optimal policy at time t s cannot always be specified at time t , even on a state-contingent basis. Hence, removing the ability of the monetary authority, for example, to use discretion in setting monetary policy is a two-edged sword. Effective precommitment to a low rate of monetary growth will mean low inflation on average, but may lower social welfare if there are unforseen negative shocks to economic activity. Conceptually, there are two aspects to the trade-off between commit- ment and flexibility, which sometimes get confused. One is the question of how much commitment is desirable in a stochastic world; the other is the technical question of how to achieve this desired level of commitment. We consider this second question in the next two chapters. The first question on the optimal degree of commitment in a stochastic world was central to discussions of macroeconomic policy long before the current interest in Ž political economy. The interested reader is referred to any policy-oriented . text on macroeconomics. The basic conceptual issues are well understood, so there is a low return to a discussion of general principles. Instead, we discuss some specific applications. T H E T I M E - C O N S I S T E N C Y P R O B L E M 127 Escape Clauses One way to try to get the benefits of commitment while still retaining flexibility is by the use of escape clauses.
eBook - PDFRecent Developments in Fisheries Economics
Special Issue of Land Economics 83:1 (February 2007)
- Ussif Rashid Sumaila, Gordon R. Munro, Jon G. Sutinen, Ussif Rashid Sumaila, Gordon R. Munro, Jon G. Sutinen(Authors)
- 2010(Publication Date)
- University of Wisconsin Press(Publisher)
Thus, in the introductory two- period example (t 5 1; 2), the consistent policy set in t 5 2 ignores the impact of that policy upon economic decisions made by the economic agents in t 5 1. The consistent policy in t 5 2 is optimal, the authors conclude, only if the period 2 policy has a zero impact upon the decisions made by the economic agents in period 1 (or, if the direct and indirect effects upon the social objective function of changes in the eco- nomic agents’ decisions in period 1, induced by the policy changes in period 2, are zero) (Kydland and Prescott 1977, 476). If expectations of the economic agents are rational, such that the economic agents in t 5 1 anticipate the policy decisions made in t 5 2, then we can look forward, with some confidence, to the period 2 time-consistent policy being decidedly sub-optimal. The essence of the time consistency problem is captured in the following quotes: ‘‘there is no mechanism to induce future policy makers to take into consideration the effect of their policy, via the expectations mech- anism, upon current decisions of [economic] agents’’ (Kydland and Prescott 1977, 481), which does, in turn, lead to the general conclusion that the ‘‘time consistent policy rule is not [the] best’’ (Prescott 2004). Turning now to the aforementioned recent JEEM article, we take, as our ex- ample, a hitherto unexploited fishery re- source, which is now, for whatever reason, open to exploitation. Initially, the fishery is a pure open-access one, subject to no, or 83(1) Clark, Munro, and Sumaila: Buyback Subsidies and the ITQ Alternative 51 wholly ineffective, harvest regulations. Over-exploitation of the resource, as to be expected, occurs. After the pure open- access fishery has achieved an equilibrium, the resource managers intervene with a vig- orous limited-entry management regime, designed to rebuild the resource to an optimal level, and to rid the fishery of any ‘‘excess’’ fleet capacity.
eBook - PDF- David R. Just(Author)
- 2013(Publication Date)
- Wiley(Publisher)
Decision makers do not display time- inconsistent preferences; their preferences today about future consumption will be realized whether they can commit to a consumption path today (as in equation 13.1) or can only commit to today’s level of consumption (as in the recursive optimization problem in equation 13.2). Choosing the consumption path implied by the recursive optimization problem implies exactly the same level of utility as committing to the consumption path that solves the standard optimization problem. Committing to a consumption path now would yield the utility stream described by z 1 = s, z 2 = w . Not committing would also yield the utility stream described by z 1 = s, z 2 = w . In fact these are identical, and thus decision makers should not be willing to give up anything to obtain a commitment mechanism. Commitment under Time Inconsistency Now consider a sophisticated person who faces the same three-period consumption problem but who discounts the utility of future consumption according to the quasi- hyperbolic discounting model. If a decision maker could commit to a consumption path now, he would choose max c 1 ,c 2 , u c 1 + T i = 2 βδ i − 2 u c i 13 14 subject to whatever budget constraint might apply. Thus, decision makers would choose the consumption path that maximizes their current perception of utility and impose this consumption stream on future (potentially unwilling) versions of themselves. Commitment under Time Inconsistency 351 People without access to a credible way to commit to future acts must then anticipate their future actions by solving the recursive optimization problem. Only now, because of the quasi-hyperbolic discount function, the problem becomes somewhat more compli- cated than that written in equation 13.2.
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