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Time-inconsistency, Democracy and Optimal Contingent Rules

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  • Minford, Patrick

Abstract

Following Kydland and Prescott's (1977) seminal paper on time-inconsistency, a large literature has explored possible frameworks within which monetary policy could overcome this problem -- neatly illustrated in Barro and Gordon's (1983) model. In a stochastic world there appears to be a trade-off between the necessary `tying of hands' to conquer the effects of time-inconsistency and the desirability of flexible response. It is in principle possible to achieve an optimal outcome by use of a discriminatory punishment, however, with a large punishment (sufficient to deter) for using policy to exploit the Phillips curve to reduce unemployment below the natural rate, but no punishment for contingent response to shocks using the same Phillips curve. This paper sets out a model of democratic elections in which floating voters may find it optimal to follow this strategy. The significance of this possibility is that regimes which permit contingent macroeconomic policy responses, while enabling prior targets to be set and policed, are superior to those which do not. This has relevance to the debate over the Exchange Rate Mechanism and the European Monetary Union.

Suggested Citation

  • Minford, Patrick, 1993. "Time-inconsistency, Democracy and Optimal Contingent Rules," CEPR Discussion Papers 767, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:767
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    Cited by:

    1. Lippi, Francesco & Swank, Otto H., 1999. "Rational Voters, Elections, and Central Banks: Do Representative Democracies Need Nonrepresentative Institutions?," Journal of Policy Modeling, Elsevier, vol. 21(4), pages 515-525, July.
    2. Adriel Jost, 2018. "Cultural Differences in Monetary Policy Preferences," Working Papers 2018-02, Swiss National Bank.
    3. Carl E. Walsh, 2002. "When should central bankers be fired?," Economics of Governance, Springer, vol. 3(1), pages 1-21, March.
    4. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-448, July.
    5. Iannis A. Mourmouras & Michael G. Arghyrou, 1999. "Monetary Policy at the European Periphery. Greek Experience and Lessons for Transition Economies," CERT Discussion Papers 9910, Centre for Economic Reform and Transformation, Heriot Watt University.
    6. António Caleiro, 2005. "How to Classify a Government? Can a Neural Network do it?," Economics Working Papers 9_2005, University of Évora, Department of Economics (Portugal).
    7. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price-level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.

    More about this item

    Keywords

    Discriminatory Punishment; Elections; Monitoring; Rules Versus Discretion; Time Inconsistency; Tying of Hands;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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