Pareto-Improving Cheating In An Economic Policy Game

This paper presents a simple repeated-game model of interaction between the government and the private sector where, at each repetition, the government first makes a non-binding announcement about its future actions. The private sector, unsure whether or not this announcement will be respected, either acts (with probability $\\pi $) as if it trusted the announcement, or disregards it in its decision-making. After observing the reaction of the private sector, the government implements the actual policy measures. Finally, the private sector updates $\\pi $ as a function of the payoff he received. We show that, although they are never respected, the government's announcements may allow reaching an outcome that improves the situation of both players\\ compared to the standard equilibrium solutions. This result is in stark contrast to the conclusions usually presented in the related economic literature.