Rules Without Commitment: Reputation and Incentives

76 Pages Posted: 11 Nov 2019

See all articles by Alessandro Dovis

Alessandro Dovis

Pennsylvania State University

Rishabh Kirpalani

University of Wisconsin - Madison

Date Written: November 2019

Abstract

This paper studies the optimal design of rules in a dynamic model when there is a time inconsistency problem and uncertainty about whether the policy maker can commit to follow the rule ex post. The policy maker can either be a commitment type, which can always commit to follow rules, or an optimizing type, which sequentially decides whether to follow rules or not. This type is unobservable to private agents, who learn about it through the actions of the policy maker. Higher beliefs that the policy maker is the commitment type (the policy maker's reputation) help promote good behavior by private agents. We show that in a large class of economies, preserving uncertainty about the policy maker's type is preferable from an ex-ante perspective. If the initial reputation is not too high, the optimal rule is the strictest one that is incentive compatible for the optimizing type. We show that reputational considerations imply that the optimal rule is more lenient than the one that would arise in a static environment. Moreover, opaque rules are preferable to transparent ones if reputation is high enough.

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Suggested Citation

Dovis, Alessandro and Kirpalani, Rishabh, Rules Without Commitment: Reputation and Incentives (November 2019). NBER Working Paper No. w26451, Available at SSRN: https://ssrn.com/abstract=3484702

Alessandro Dovis (Contact Author)

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

Rishabh Kirpalani

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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