Instrument-Based vs. Target-Based Rules

29 Pages Posted: 3 Apr 2018

See all articles by Marina Halac

Marina Halac

Columbia University

Pierre Yared

Columbia Business School - Finance and Economics

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Date Written: April 2, 2018

Abstract

We develop a simple delegation model to study rules based on instruments vs. targets. A principal faces a better informed but biased agent and relies on joint punishments as incentives. Instrument-based rules condition incentives on the agent's observable action; target-based rules condition incentives on outcomes that depend on the agent's action and private information. In each class, an optimal rule takes a threshold form and imposes the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the agent's information is sufficiently precise. An optimal hybrid rule relaxes the instrument threshold whenever the target threshold is satisfied.

Keywords: Policy Rules, Private Information, Delegation, Mechanism Design

JEL Classification: D02, D82, E58, E61

Suggested Citation

Halac, Marina and Yared, Pierre, Instrument-Based vs. Target-Based Rules (April 2, 2018). Columbia Business School Research Paper No. 18-34. Available at SSRN: https://ssrn.com/abstract=3155189 or http://dx.doi.org/10.2139/ssrn.3155189

Marina Halac

Columbia University ( email )

Pierre Yared (Contact Author)

Columbia Business School - Finance and Economics ( email )

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