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Loose commitment

  • Davide Debortoli
  • Ricardo Nunes

Due to time-inconsistency or policymakers' turnover, economic promises are not always fulfilled and plans are revised periodically. This fact is not accounted for in the commitment or the discretion approach. We consider two settings where the planner occasionally defaults on past promises. In the first setting, a default may occur in any period with a given probability. In the second, we make the likelihood of default a function of endogenous variables. We formulate these problems recursively, and provide techniques that can be applied to a general class of models. Our method can be used to analyze the plausibility and the importance of commitment and characterize optimal policy in a more realistic environment. We illustrate the method and results in a fiscal policy application.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 916.

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Date of creation: 2007
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Handle: RePEc:fip:fedgif:916
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  1. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  2. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  3. Pierpaolo Benigno & Michael Woodford, 2008. "Linear-Quadratic Approximation of Optimal Policy Problems," Discussion Papers 0809-01, Columbia University, Department of Economics.
  4. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  5. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  6. Tabellini, Guido & Alesina, Alberto, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Scholarly Articles 3612769, Harvard University Department of Economics.
  7. Per Krusell & Fernando M. Martin & Jose-Victor Rios-Rull, 2006. "Time Consistent Debt," 2006 Meeting Papers 210, Society for Economic Dynamics.
  8. Paul Klein & Per Krusell & José-Víctor Ríos-Rull, 2004. "Time-Consistent Public Expenditures," Levine's Bibliography 122247000000000652, UCLA Department of Economics.
  9. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  10. Ricardo Nunes & Davide Debortoli, 2007. "Political Disagreement, Lack of Commitment and the Level of Debt," 2007 Meeting Papers 725, Society for Economic Dynamics.
  11. Benhabib, Jess & Rustichini, Aldo, 1997. "Optimal Taxes without Commitment," Journal of Economic Theory, Elsevier, vol. 77(2), pages 231-259, December.
  12. Debortoli, Davide & Nunes, Ricardo, 2006. "On Linear Quadratic Approximations," MPRA Paper 544, University Library of Munich, Germany, revised Jul 2006.
  13. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  14. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November.
  15. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  16. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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