Policy and Welfare Effects of Within-Period Commitment

Abstract:     
Public expenditure is inefficiently low when a benevolent government can only commit to policies within a period. If the government loses the ability to commit within-period, then it stops internalizing some of the distortions created by current policy. Thus, to counterbalance the costs of future distortions, it increases public good provision, which may improve welfare. For a calibrated economy, removing within-period commitment implies a welfare gain worth half-a-percent of yearly consumption. A similar gain can be obtained, if instead, capital depreciation were allowed to be fully deducted from taxable income. However, enacting both reforms may lead to large welfare losses.

Number of Pages in PDF File: 25

Keywords: scal policy, time-consistency, lack of commitment, Markov-perfect equilibrium

JEL Classification: E61, E62

working papers series