A Political Model of Credibility

It is argued that trigger mechanisms cannot support reputation if voters are atomistic and have access to good information about party preferences. Therefore the choice for a party lies between precommitment, enforced by penalties, and discretion. The paper uses a model of Labor and Conservative preferences derived from Minford and Peel (1982) and estimates the difference of policies and outcomes for each party over an electoral period. Under discretion inflation is 10-30 per cent higher than under precommitment and unemployment is temporarily and modestly lower; under precommitment inflation is negligible (Labour is only slightly more inflationary in this case). Higher levels of welfare are achieved under both parties with precommitment but the penalties would have to be greater under Labour to support this strategy. The paper therefore suggests that rational policy should never have been discretionary in practice; episodes of apparent discretion may therefore have simply represented mistakes in attempted precommitment. An implication of modelling government preferences explicitly (appendix) is that the Lucas critique has little scope over policy change, since agents are fully aware of these preferences.