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Credibility and Time Inconsistency in a Stochastic World


  • Currie, David
  • Levine, Paul L


This paper re-examines the issue of the credibility and sustainability of optimal policies derived from Pontryagin's Maximum Principle and generally regarded as time-inconsistent, in models with forward-looking rational expectations. Specifically, it considers the behaviour of such models in the presence of continuing stochastic noise. This is shown to convert the policy problem from a one-shot dynamic policy game to a continuing game, giving governments an incentive to invest in a reputation for not reneging on the full optimal rule. This incentive may, in certain circumstances, render the full optimal rule credible and therefore sustainable. It is demonstrated that a sufficiently low degree of discounting on the part of government, or a sufficiently high variance of shocks (measured relative to the initial displacement) ensures the sustainability of the full optimal rule. Using a simple dynamic open economy model, these conditions are shown to be plausible unless the discount rate is very high.

Suggested Citation

  • Currie, David & Levine, Paul L, 1986. "Credibility and Time Inconsistency in a Stochastic World," CEPR Discussion Papers 94, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:94

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    References listed on IDEAS

    1. Buira, Ariel, 1983. "IMF financial programs and conditionality," Journal of Development Economics, Elsevier, vol. 12(1-2), pages 111-136.
    2. Marini, Giancarlo, 1985. "Intertemporal Substitution and the Role of Monetary Policy," Economic Journal, Royal Economic Society, vol. 95(377), pages 87-100, March.
    3. Buffie, Edward F., 1984. "The macroeconomics of trade liberalization," Journal of International Economics, Elsevier, vol. 17(1-2), pages 121-137, August.
    4. Weiss, Laurence M, 1980. "The Role for Active Monetary Policy in a Rational Expectations Model," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 221-233, April.
    5. Kapur, Basant K, 1976. "Alternative Stabilization Policies for Less-developed Economies," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 777-795, August.
    6. Katseli, Louka T, 1983. "Devaluation: A Critical Appraisal of the IMF's Policy Prescriptions," American Economic Review, American Economic Association, vol. 73(2), pages 359-363, May.
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    Cited by:

    1. Juha Kilponen, 2004. "Robust expectations and uncertain models – A robust control approach with application to the New Keynesian economy," GE, Growth, Math methods 0404004, EconWPA.
    2. M. Isabel García Gracia, 1995. "El SME: un modelo de comportamiento asimétrico," Estudios de Economía Aplicada, Estudios de Economía Aplicada, vol. 3, pages 41-68, Junio.
    3. Warwick J. McKibbin & Jeffrey D. Sachs, 1986. "Comparing the Performance of Alternative Exchange Arrangements," NBER Working Papers 2024, National Bureau of Economic Research, Inc.
    4. Cristiano Cantore & Vasco J. Gabriel & Paul Levine & Joseph Pearlman & Bo Yang, 2013. "The science and art of DSGE modelling: II – model comparisons, model validation, policy analysis and general discussion," Chapters,in: Handbook of Research Methods and Applications in Empirical Macroeconomics, chapter 19, pages 441-463 Edward Elgar Publishing.


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