Pre-committed Policy Research Articles

Assessing the effects of a precommitment policy applied during peer review

Assessing the effects of a precommitment policy applied during peer review

Time consistent in efficiency dynamic mean–variance policy

The dynamic mean–variance formulation for a market with all risky assets is not time consistent in efficiency (TCIE), in the sense that the pre-committed policy, which is optimal for the entire investment horizon, could become mean–variance inefficient when facing a truncated time-horizon problem at an intermediate time instant. By removing the self-financing restriction and fully avoiding the irrational investment behaviours in intermediate time periods, we develop the TCIE dynamic mean–variance policy, which is TCIE. Comparing to the polices in the literature, such as the strictly dominating policy, the pre-committed policy and the time consistent policy, the TCIE policy can achieve better global investment performance.

Better than optimal mean–variance portfolio policy in multi-period asset–liability management problem

When the wealth is larger than some threshold in multi-period mean–variance asset–liability management, the pre-committed policy is no longer mean–variance efficient policy for the remaining investment horizon. To revise the policy, by relaxing self-financing constraint and allowing to withdraw some wealth, we derive a new dominating policy, which is better than the pre-committed policy. The revised policy can achieve the same mean–variance pairs attained by the pre-committed policy, and yields a nonnegative free cash flow stream over the investment horizon.

Better than pre-committed optimal mean-variance policy in a jump diffusion market

Dynamic mean-variance investment model can not be solved by dynamic programming directly due to the nonseparable structure of variance minimization problem. Instead of adopting embedding scheme, Lagrangian duality approach or mean-variance hedging approach, we transfer the model into mean field mean-variance formulation and derive the explicit pre-committed optimal mean-variance policy in a jump diffusion market. Similar to multi-period setting, the pre-committed optimal mean-variance policy is not time consistent in efficiency. When the wealth level of the investor exceeds some pre-given level, following pre-committed optimal mean-variance policy leads to irrational investment behaviors. Thus, we propose a semi-self-financing revised policy, in which the investor is allowed to withdraw partial of his wealth out of the market. And show the revised policy has a better investment performance in the sense of achieving the same mean-variance pair as pre-committed policy and receiving a nonnegative free cash flow stream.

Time consistent policy of multi-period mean-variance problem in stochastic markets

Due to the non-separability of the variance operator, the optimal investment policy of the multi-period mean-variance model in Markovian markets doesn't satisfy the time consistency. We propose a new weak time consistency in stochastic markets and show that the pre-commitment optimal policy satisfies the weak time consistency at any intermediate period as long as the investor's wealth is no more than a specific threshold. When the investor's wealth exceeds the threshold, the weak time consistency no longer holds. In this case, by modifying the pre-commitment optimal policy, we derive a wealth interval, from which we determine a more efficient revised policy. The terminal wealth obtained under this revised policy can achieve the same mean as, but not greater variance than those of the terminal wealth obtained under the pre-commitment optimal policy; a series of superior investment policies can be obtained depending on the degree the investor wants the conditional variance to decrease. It is shown that, in the above revising process, a positive cash flow can be taken out of the market. Finally, an empirical example illustrates our theoretical results. Our results generalize existing conclusions for the multi-period mean-variance model in deterministic markets.

Fiscal Sustainability in a New Keynesian Model

Recent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady‐state debt to follow a random walk. In this paper we consider the nature of the time inconsistency involved in such a policy and its implication for discretionary policymaking. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady‐state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government's objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi‐commitment policy, which allows for different probabilities of reneging on past promises.

Law as a Bargaining Strategy for Dealing with Terrorist Kidnapping

The question of how to react to ransom demands in kidnap situations is ancient and persistent. It was asked as far back as Biblical times, and yet modern states have still not found answers. In terrorist kidnapping scenarios, the private victims, including the family, are often used as leverage to pressure the authorities, with the anticipation that the combination of public sympathy and private lobbying will result in excessive concessions. In the kidnap game, the victim’s family is a single-game player and thus operates under a completely different set of considerations than the repeat player: the state. The question is how the repeat player is able to resist the one-off appearance of a particular kidnap victim and the pressure to concede to terrorist demands. The problem is compounded by an inflation effect in that each concession becomes the baseline for the next. Predictably, democracies do not deal well with this issue, and they may find themselves in a vicious cycle where ransom demands are repeatedly raised and conceded to, creating greater incentives toward kidnapping. This article identifies both why precommitment is the necessary solution to repeat kidnapping situations, and why it is a difficult solution to abide by. It argues that the world has so far tested only content-based precommitment strategies such as setting red-lines regarding what prices states will not pay. These policies have largely failed to constrain states’ concessions to terrorists. As an alternative, this article argues that states should adopt only structural-procedural precommitment policies, and explains how this may serve as an antidote to some of the pressure for escalation.

Paternalism and the Pokies: Unjustified State Interference or Justifiable Intervention?

The Australian Productivity Commission and a Joint Select Committee on Gambling Reform have recommended implementation of a mandatory pre-commitment system for electronic gambling. Organizations associated with the gambling industry have protested that such interventions reduce individual rights, and will cause a reduction in revenue which will cost jobs and reduce gaming venue support for local communities. This article is not concerned with the design details or the evidence base of the proposed scheme, but rather with the fundamental criticism that a mandatory pre-commitment policy is an unacceptable interference with the liberty of the individual, and of organizations. It is argued that the concept of paternalism is a useful lens with which to study the interactions between business and society on this issue. It is contended that the benefits of a pre-commitment system to problem gamblers and society are socially and economically significant, and the cost to recreational gamblers, particularly the cost in terms of interference with the liberty of the individual, is minimal. Pre-commitment also requires gambling businesses to act in a more socially responsible manner. It is concluded that the proposed legislation constitutes a paternalistic intervention by government on the interaction between business and society, and that this is justified.

Renewable Energy Policy in the Presence of Innovation: Does Government Pre-Commitment Matter?

In a perfectly competitive market with a possibility of technological innovation we contrast guaranteed feed-in tariffs for electricity from renewables and tradable green certificates from a dynamic efficiency and social welfare point of view. Specifically, we model decisions about the technological innovation with convex costs within the framework of a game-theoretic model, and discuss implications for optimal policy design under different assumptions regarding regulatory pre-commitment. We find that for the case of technological innovation with convex costs subsidy policies are preferable over quota-based policies. Further, in terms of dynamic efficiency, no pre-commitment policies are shown to be at least as good as the pre-commitment ones. Thus, a government with a preference for innovation being performed if the achievable cost reduction is high should be in favor of the no pre-commitment regime.

Gambling Motivations, Money-Limiting Strategies, and Precommitment Preferences of Problem Versus Non-Problem Gamblers

Studies attempting to identify the specific 'addictive' features of electronic gaming machines (EGMs) have yielded largely inconclusive results, suggesting that it is the interaction between a gambler's cognitions and the machine, rather than the machine itself, which fuels excessive play. Research has reported that machine players with gambling problems adopt a number of erroneous cognitive perceptions regarding the probability of winning and the nature of randomness. What is unknown, however, is whether motivations for gambling and attitudes toward pre-session monetary limit-setting vary across levels of gambling severity, and whether proposed precommitment strategies would be useful in minimizing excessive gambling expenditures. The current study explored these concepts in a sample of 127 adults, ages 18 to 81, attending one of four gambling venues in Queensland, Australia. The study found that problem gamblers were more likely than other gamblers to play machines to earn income or escape their problems rather than for fun and enjoyment. Similarly, they were less likely to endorse any type of monetary limit-setting prior to play. They were also reticent to adopt the use of a 'smart card' or other strategy to limit access to money during a session, though they indicated they lost track of money while gambling and were rarely aware of whether they were winning or losing during play. Implications for precommitment policies and further research are discussed.

Renewable Energy Policy in the Presence of Innovation: Does Government Pre-Commitment Matter?

In a perfectly competitive market with a possibility of technological innovation we contrast guaranteed feed-in tariffs for electricity from renewables and tradable green certificates from a dynamic efficiency and social welfare point of view. Specifically, we model decisions about the technological innovation with convex costs within the framework of a game-theoretic model, and discuss implications for optimal policy design under different assumptions regarding regulatory pre-commitment. We find that for the case of technological innovation with convex costs subsidy policies are preferable over quota-based policies. Further, in terms of dynamic efficiency, no pre-commitment policies are shown to be at least as good as the pre-commitment ones. Thus, a government with a preference for innovation being performed if the achievable cost reduction is high should be in favor of the no pre-commitment regime.

Endogenous Persistence and the Performance of Inertial Targeting Rules

We investigate the optimality of monetary policy targeting rules in a macroeconomic model based on explicit micro-foundations for intrinsic persistence in inflation and real output. For the corresponding social welfare loss function to be minimized by the central bank, inertia arises endogenously in both the inflation and output gap stabilization objectives. In this framework, inflation targeting closely approximates the optimal precommitment policy for empirically relevant parameter values. Alternative policy rules, such as nominal income growth targeting, "speed-limit" targeting, or price level targeting, do not perform as well. Previous research has demonstrated lower social welfare losses with these alternative targeting rules; such findings are shown to be primarily a consequence of assuming the central bank minimizes a simple social loss function that is not consistent with the micro-foundations of a model with intrinsic persistence.

Endogenous Persistence and the Performance of Inertial Targeting Rules

We investigate the optimality of monetary policy targeting rules in a macroeconomic model based on explicit micro-foundations for intrinsic persistence in inflation and real output. For the corresponding social welfare loss function to be minimized by the central bank, inertia arises endogenously in both the inflation and output gap stabilization objectives. In this framework, inflation targeting closely approximates the optimal precommitment policy for empirically relevant parameter values. Alternative policy rules, such as nominal income growth targeting, “speed-limit” targeting, or price level targeting, do not perform as well. Previous research has demonstrated lower social welfare losses with these alternative targeting rules; such findings are shown to be primarily a consequence of assuming the central bank minimizes a simple social loss function that is not consistent with the micro-foundations of a model with intrinsic persistence.

Open-Economy Inflation- Forecast Targeting

Abstract We study simple inflation-forecast targeting in an open-economy setting. Simple inflation-forecast targeting implies setting an interest rate which, if kept unchanged throughout the forecast-targeting horizon, produces a conditional inflation forecast equal to the inflation target at the end of the horizon.We find that the optimal forecast-targeting horizon is relatively short (one year). A longer horizon does not consistently contribute to improved output stability, indeed it increases exchange rate variability and traded sector variability. The targeting procedure is substantially inferior to the optimal pre-commitment policy. Moreover, the targeting procedure does not necessarily determine the rational-expectations equilibrium and is subject to time inconsistency.

Fiscal Sustainability in a New Keynesian Model

There has been a wealth of recent work deriving optimal monetary policy utilising New Neo-Classical Synthesis (NNCS) models based on nominal inertia. Such models typically abstract from the impact of monetary policy on the government's finances, by assuming that consumers are infinitely-lived and taxes are lump-sum such that Ricardian Equivalence holds. In this paper, in the context of a sticky-price NNCS model, we assume that the government must adjust spending and/or distortionary taxation to satisfy its intertemporal budget constraint. We then consider optimal monetary and fiscal policies under discretion and commitment in the face of technology, preference and cost-push shocks. We find that the optimal precommitment policy implies a random walk in the steady-state level of debt, generalising earlier results that involved only a single fiscal instrument. In the case of negative fiscal shocks this implies permanently higher taxation and lower output and government spending to support the new steady-state debt shock, but the optimal combination of these variables will ensure a zero rate of inflation under commitment. We also find that the time-inconsistency in the optimal precommitment policy is such that governemnts are tempted, given inflationary expectations, to raise taxation to reduce the ultimate debt burden they need to service. Since taxation is a distortionary labour income tax, this aggresive raising of taxation raises firms' marginal costs and fuels inflation. We show that this temptation is only eliminated if following shocks, the new steady-state debt is equal to the original, first-best, debt level. This implies that under discretionary policy the random walk result is over-turned: debt will always be returned to this initial steady-state even although there is no explicit debt target in the government's objective function. In a series of numerical simulations we show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy.

Revisiting the Delegation Problem in a Sticky Price and Wage Economy

In a stylized economy with price and wage stickiness, this paper argues that delegating a nominal wage target to a central bank operating under discretion generally delivers better social outcomes than delegating price level or in∞ation targets. Although both policies impart inertia into central bank actions, wage targeting dominates price level targeting because the former delivers a more favorable tradeofi between the stabilization goals appearing in the social welfare function, namely, price in∞ation, wage in∞ation, and the output gap. Delegation of a dual policy featuring both price level and nominal wage targets, however, nearly replicates the e‐cient outcome accompanying the precommitment policy from a timeless perspective.

Pre-commitment, the Timeless Perspective, and Policymaking from Behind a Veil of Uncertainty

Woodford (1999) develops the notion of a timelessly optimal pre-commitment policy. This paper uses a simple business cycle model to illustrate this notion. We show that timelessly optimal policies are not unique and that they are not necessarily better than the time-consistent solution. Further, we describe a method for constructing optimal pre-commitment rules in an environment where the policymaker does not know the initial state of the economy. This latter solution is useful for characterizing the benefits policymakers extract through exploiting initial conditions.

Speed Limit Policies: The Output Gap and Optimal Monetary Policy

In a standard New Keynesian model, a myopic central bank concerned with stabilizing inflation and changes in the output gap will implement a policy under discretion that replicates the optimal, timeless perspective, precommitment policy. By stabilizing output gap changes, the central bank imparts inertia into output and inflation that is absent under pure discretion. Even a fully optimizing (i.e., non-myopic) central bank operating in a discretionary policy environment achieves better social outcomes if it focuses on inflation and changes in the output gap than are achieved under inflation targeting.(This abstract was borrowed from another version of this item.)

Debt-contingent inflation contracts and targets

This paper analyzes fiscal and monetary policy interaction in a simple policy game with debt and output shocks. Seigniorage provides revenue for the government but results in an inflation-bias. We analyze three mechanisms designed to eliminate some or all of the biases in monetary policy: an inflation performance contract, inflation target (both contingent on the stock of debt), and a zero-inflation rule. The performance contract and inflation target result in higher interest rate, remove all biases in monetary policy and achieve the pre-commitment policy, hence they are equivalent. The first two solutions also yield a higher expected welfare than a zero-inflation policy.

Precommitment, the Timeless Perspective, and Policymaking from Behind a Veil of Uncertainty

Woodford (1999) develops the notion of a “timelessly optimal” pre-commitment policy. This paper uses a simple business cycle model to illustrate this notion. We show that timelessly optimal policies are not unique and that they are not necessarily better than the time-consistent solution. Further, we describe a method for constructing optimal precommitment rules in an environment where the policymaker does not know the initial state of the economy. This latter solution is useful for characterizing the benefits policymakers extract through exploiting initial conditions. • The views expressed in this paper are those of the author and do not necessary reflect those of