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Monday, January 29, 2018

Time Consistency: A Primer

From Cecchetti & Schoenholtz:

Time Consistency: A Primer: “[S]ome useful policy strategies are ‘rule-like’, in that by their forward-looking nature they constrain central banks from systematically engaging in policies with undesirable long-run consequences.” Ben S. Bernanke and Frederic S. Mishkin, “Inflation Targeting: A New Framework for Monetary Policy,” Spring 1997.
The problem of time consistency is one of the most profound in social science. With applications in areas ranging from economic policy to counterterrorism, it arises whenever the effectiveness of a policy today depends on the credibility of the commitment to implement that policy in the future.
For simplicity, we will define a time consistent policy as one where a future policymaker lacks the opportunity or the incentive to renege. Conversely, a policy lacks time consistency when a future policymaker has both the means and the motivation to break the commitment.
In this post, we describe the conceptual origins of time consistency. To emphasize its broad importance, we provide three economic examples—in monetary policy, prudential regulation, and tax policy—where the impact of the idea is especially notable. (For other examples, see here and here.) ...

    Posted by on Monday, January 29, 2018 at 11:09 AM in Economics, Policy | Permalink  Comments (31)


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