Time-consistency Problem Research Articles

Credibility and Reform of Financial Institution Regulation

There is heightened interest in reforming government regulation of financial institutions to make better use of market discipline and data. We strongly support such reforms, which are being implemented to some degree by the Federal Reserve System. However, market oriented reforms will not work unless government policies are credible in putting market participants, especially those at the largest financial institutions, at risk of loss. Establishing credible policies requires that governments address the time-consistency problem head-on. As a result, we recommend policies that establish credibility by directly reducing the incentive that policy-makers have to protect the creditors of financial institutions. Other policies, which do not address the fundamental reasons why policy-makers bail out creditors, are therefore likely to be circumvented when large banks get into trouble.

Privacy and time-consistent optimal labor income taxation

Incomplete information is a commitment device for time-consistency problems. In the context of time-consistent optimal labor income taxation privacy can lead to a Pareto superior outcome and increases the effectiveness of public education as a second best policy.

Globalization and Human Capital Formation

This paper compares education investment in closed and open economies without government and with a benevolent government. The fact that the time consistency problem in taxation can make labor mobility beneficial even if governments are fully benevolent - which is known from other contexts - is shown to be true in the economies considered. It is further shown that labor mobility is unambiguously beneficial if private insurance for human capital investment is available.

Retirment Savings in an Aging Society: A Case for Innovative Government Debt Management

Aging societies will have to rely increasingly on private savings to finance retirement. The natural savings vehicles, stocks and bonds, are unfortunately lacking key risk-sharing features that are built into public retirement. Innovative government debt management can address this problem. The optimal policy supplies retirees with securities that share the financial risks of aggregate productivity, asset valuation, and demographic shocks across generations. As the population ages, state-contingent government bonds are a better risk sharing tools than pensions, which become too costly, or taxation, which raises time-consistency problems. Wage-indexed and longevity-indexed bonds in particular yield unambiguous efficiency improvements. To the extent that public pensions remain important, plans with wage-indexed defined benefits seem preferable to defined contributions or price-indexed plans. Capital income taxes and pension trust funds can play a supporting role for risk sharing.

Fed Chat: FOMC Transcripts and the Politics of Monetary Policymaking

This paper investigates a variety of issues related to aspects of monetary policymaking. The approach is anecdotal - it is based on our reading of textual records from meetings of the FOMC during Arthur Burns's years as Chairman of the Federal Reserve Board. These records include Memoranda of Discussion for meetings between 1970 and 1976, and verbatim transcripts of meetings held between 1976 and 1978. The latter were obtained from Arthur Burns's personal papers and are the only verbatim transcripts of policy meetings available from any major central bank. We use the records to investigate sources of influence on policymakers: pressures from the President, the Congress, and the public. We investigate the timing of elections and the possibility of a political business cycle in monetary policy. We evaluate issues related to credibility and the time consistency problem as an explanation for an inflationary bias. Further, we discuss the role of committee decision-making institutions, information strategies, and inertial forces in shaping the decisions of the Federal Open Market Committee (FOMC).

Symbiosis of Monetary and Fiscal Policies in a Monetary Union

We consider the interaction between the monetary policy of a common central bank in a monetary union, and the separate fiscal policies of the member countries. We construct a model of the Barro-Gordon type extended to many countries and countercyclical fiscal stabilization policies. Each country's fiscal policies inflict positive (output expansion) and negative (inflation) externalities on other countries, and the common monetary policy has its time-consistency problem. But we find that each kind of policy helps solve the other kind's problem. The first-best can be achieved despite the inevitability of some ex post monetary accommodation to fiscal profligacy, without the need for fiscal coordination, without the need for monetary commitment, without the need for a conservative central bank, and irrespective of whether the fiscal or the monetary authorities have the first move.

Privacy, Time Consistent Optimal Labor Income Taxation And Education Policy

Incomplete information is a commitment device for time consistency problems. In the context of time consistent labor income taxation privacy can lead to a Pareto superior outcome and increases the effectiveness of public education as a second best policy.

Fiscal Policy Through Time-Varying Tax Rates: If and How

This paper investigates if there are circumstances where time-varying tax rates could improve welfare and whether such policy can effectively be implemented in practice. While, in principle, variable taxes could improve welfare in some cases, the paper highlights the very particular circumstances that need to prevail. With liquidity constraints, a consumption-tax break is in a better footing to boost consumption and welfare than an income-tax break. A hike in consumption taxes can also be used to restrain consumption and improve welfare under time-consistency problems induced by hyperbolic discounting. However, variable taxes are subject to serious implementation problems fettering their use.

Fiscal Policy Through Time-Varying Tax Rates If and How

This paper investigates if there are circumstances where time-varying tax rates could improve welfare and whether such policy can effectively be implemented in practice. While, in principle, variable taxes could improve welfare in some cases, the paper highlights the very particular circumstances that need to prevail. With liquidity constraints, a consumption-tax break is in a better footing to boost consumption and welfare than an income-tax break. A hike in consumption taxes can also be used to restrain consumption and improve welfare under time-consistency problems induced by hyperbolic discounting. However, variable taxes are subject to serious implementation problems fettering their use.

Does the time-consistency problem explain the behavior of inflation in the United States?

This paper derives the restrictions imposed by Barro and Gordon's theory of time-consistent monetary policy on a bivariate time-series model for inflation and unemployment and tests those restrictions using quarterly US data from 1960 through 1997. The results show that the data are consistent with the implications of the theory for the long-run behavior of the two variables, indicating that the theory can explain the initial rise and subsequent fall of inflation over the past four decades. The results also suggest that the theory must be extended to account more fully for the short-run dynamics that appear in the data.

Checks and balances, and the supply of central bank independence

The paper analyzes the institutional conditions under which policymakers can credibly commit to an independent central bank and thereby mitigate the well-known time consistency problem in monetary policy. It is shown theoretically that granting independence via a statute is only credible for legislative systems with at least two heterogeneous decision-making bodies which both have veto rights (for example bicameral systems). This thesis is supported by empirical evidence: The legal independence of central banks is significantly higher in those OECD countries whose legislative processes are characterized by extensive checks and balances. Furthermore, the negative relation between legal independence and inflation is larger in countries with checks and balances than in countries without checks and balances.

Rational Voters, Elections, and Central Banks: Do Representative Democracies Need Nonrepresentative Institutions?

We show that the welfare-improving property of an independent central bank depends on how voters respond to the time consistency problem. Voters' responsiveness to economic problems may provide some flexibility to revise the policy delegation arrangement of the central bank. This may improve social welfare. Preliminary evidence on voters' behavior in the U.S. is presented, which indicates that voters seem to respond to economic problems in a proper way, taking time-consistency problems into account when making their vote decisions.

Central bank independence and output variability

The benefit of greater central bank independence is the reduction in inflation that should result from the mitigation of a country's time consistency problem. The cost of greater independence is the loss of discretionary monetary policymaking, and consequent increase in output variability. Empirically however, there is no correlation between output variability and central bank independence. A possible explanation for this lack of correlation is that countries which are more likely to have lower output variability are also more likely to choose to have an independent central bank. This hypothesis is tested using data for 44 countries. While the evidence is weakly consistent with this hypothesis, this does not seem sufficient to explain the zero correlation between output variability and central bank independence.

Dynamic Consistency Under Asymmetric Information

The time consistency problem is recast in an imperfect information framework. A two-period, two-agent dynamic game is examined. The loop model of dynamic games is used. Agents are assumed to possess imperfect information about the value of the state variable in each period. It is shown that a consistency in the outcomes of the Nash game and the associated Stackelberg game exists. Under dynamic information patterns, both players prefer to play the Stackelberg game than the Nash game.

Sustainable monetary policies

Abstract This paper uses a model with utility maximizing households, monopolistically competitive firms, and sticky goods prices to derive a version of Barro and Gordon's time consistency problem for monetary policy where the government's objectives are consistent with a representative household's preferences. The paper applies the methods of Chari and Kehoe to characterize the entire set of time consistent, or sustainable, outcomes. It goes on to find conditions under which the Friedman rule, the optimal policy under commitment, can be supported when the government lacks a commitment technology.

Individual and Collective Time-Consistency

This paper reconsiders the Strotz-Pollak problem of consistent planning and argues that a solution to this problem requires a refinement of subgame-perfectness. Such a refinement is offered through an analysis based on Greenberg's theory of social situations. The properties of this refinement are investigated and illustrated. A unifying framework is presented whereby consistent one-person planning as a problem of individual time-consistency and renegotiation-proofness as a problem of collective time-consistency are captured through the same general concept.

The financial structure of government debt in OECD countries: An examination of the time-consistency issue

This paper analyzes the financial structure of government debt in the OECD countries from the perspective of time-consistency problems with a focus on debt held by financial institutions. Testable implications from a theoretical time-consistency model are derived and incorporated into the framework of a cost-minimizing model for public debt service. The approach is tested for a sample of 15 OECD countries over the period 1974–1989. The theoretical analysis and the empirical results show how, in addition to maturity, ownership of government debt in those OECD countries with debt accumulation problems can be related to time-consistency considerations.

Time Consistent Collection of Optimal Seigniorage: A Unifying Framework

This paper reviews the existing literature on the time consistency problem of seigniorage collection when monetary policy is determined by optimal taxation considerations. It develops a unifying accounting framework and suggests a general measure for seigniorage, which encompasses the standard measures employed in the literature. In addition, the ex ante optimal solution to the optimal taxation problem is derived and interpreted in relation to the Ramsey principle. We show that the different recommendations of the public finance literature, i.e. the Friedman rule of optimal deflation, [moderately] positive inflation, and seigniorage maximizing inflation, are specific solutions to the optimal taxation problem. The paper continues with a formal illustration of the time consistency problem of the ex ante optimal policy and the characterization of the time consistent solution under discretion. As possible solutions to the time consistency problem, we consider reputational forces, institutional reforms that establish central bank independence, and specific ways of asset and debt management. In particular, it is formally shown that a modified version of the asset and debt management scheme suggested by Persson, Persson, and Svensson is not only necessary but also sufficient for optimality, although this did not hold in their model.

Time Consistent Taxation by a Government with Redistributive Goals

In a dynamic economy whose government is interested in both equity and efficiency, time consistency problems arise even if the government has access to nondistortionary tax instruments. Moral hazard in production leads to a nondegenerate distribution of income, which the government would like to “flatten” ex post. Self-enforcing social agreements can mitigate the tendency toward excessive redistribution. We investigate the nature of the distortions caused by the time consistency problem, and show that in the constrained-optimal equilibrium, usually alineartax schedule is imposed. This remains true if renegotiation of the social agreement is possible.Journal of Economic LiteratureClassification Numbers: C7 C73, E6, H21.

Temporal Properties in Distributed Real-Time Applications Cooperation Models and Communication Types

Real-time distributed applications axe composed of a set of cooperative tasks that interact between them. These interactions are time constrained because of the reactive nature of the application. We also have time coherence and consistency problems issued from the distributed nature of the system. We present one model based on the concepts of events to describe precisely the time properties of cooperating processes on actions and data interactions, and the time characteristics of the communication services. A temporal logic is used for the formal description.