Loose Commitment

44 Pages Posted: 19 May 2006

See all articles by Davide Debortoli

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE)

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: December 2007

Abstract

Due to time-inconsistency or policymakers' turnover, economic promises are not always fulfilled and plans are revised periodically. This fact is not accounted for in the commitment or the discretion approach. We consider two settings where the planner occasionally defaults on past promises. In the first setting, a default may occur in any period with a given probability. In the second, we make the likelihood of default a function of endogenous variables. We formulate these problems recursively, and provide techniques that can be applied to a general class of models. Our method can be used to analyze the plausibility and the importance of commitment and characterize optimal policy in a more realistic environment. We illustrate the method and results in a fiscal policy application.

Keywords: Commitment, Discretion, Fiscal Policy

JEL Classification: C61, C63, E61, E62

Suggested Citation

Debortoli, Davide and Nunes, Ricardo Cavaco, Loose Commitment (December 2007). FRB International Finance Discussion Paper No. 916, Available at SSRN: https://ssrn.com/abstract=903122 or http://dx.doi.org/10.2139/ssrn.903122

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business ( email )

Barcelona
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Ricardo Cavaco Nunes (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

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