DP536 | Which `Simple' Rules Rather than Discretion?

Publication Date

01/03/1991

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Abstract

The dynamic inconsistency of a government's preferred policy, when it occurs, usually implies that the maximum level of welfare that can be delivered at some initial time can only be attained by constraining the economy to `low' levels in the future. In this paper, we set up a linear quadratic model in which the `best' policy rule which is looked for today is subject to the constraint of always delivering in the future a given reservation level of welfare which in equilibrium is the level that the `best' policy itself offers to deliver. We fully characterize the solutions to this problem in the cases when the government policies are constant, linear and kinked linear.