The New Palgrave Dictionary of Economics

2018 Edition
| Editors: Macmillan Publishers Ltd

Time Consistency of Monetary and Fiscal Policy

  • Paul Klein
Reference work entry
DOI: https://doi.org/10.1057/978-1-349-95189-5_2479

Abstract

Why do even benevolent policymakers frequently break their promises? Kydland and Prescott (1977) discovered that, when outcomes depend on expectations, rational policy choices typically depend on whether (a) the policymaker takes into account the constraint that the expected policy is the actual policy or (b) she takes expectations as given. A government that commits itself to a policy takes this constraint into account, a government that acts at its discretion does not. Since the commitment policy leads to a better outcome, there is the temptation to announce it and then to abandon this policy. This is the time inconsistency problem.

Keywords

Asymmetric information Central bank independence Commitment Expectations Friedman rule Government budget constraint Inflation Inflationary expectations Markov perfect equilibrium Phillips curve Public debt Ramsey equilibrium Rational expectations Reputation Second best Sticky prices Sustainable equilibrium Time consistency of monetary and fiscal policy Time inconsistency 
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Copyright information

© Macmillan Publishers Ltd. 2018

Authors and Affiliations

  • Paul Klein
    • 1
  1. 1.