Dynamic Commitment and Incomplete Policy Rules

Abstract

Considering the dynamics of commitment highlights some neglected features of inconsistency problems. We modify the standard rules-versus-discretion question in three ways: (1) A government that does not commit today retains the option to do so tomorrow, (2) the government's commitment capability is restricted to a class of simple rules, and (3) the government's ability to make irrevocable commitments is restricted. Three results stand out. First, the option to wait makes the incumbent regime (rules or discretion) relatively more attractive. Second, the option to wait means that increased uncertainty makes the incumbent regime more attlwactive. Third, because the commitment decision takes place in real time, policy choice displays hysteresis. WHEN MONETARY POLICY is subject to dynamic inconsistencies, optimal policy requires some precommitment by the central bank. Despite a proliferation of mechanisms designed to address this problem, work in this area has continued to assume a once-and-for-all-choice between rules and discretion. This paper asks two closely related questions: First, what happens if commitment decisions are made in real time so that failure to commit today does not rule out the possibility of commitment tomorrow? Second, if governments can make only commitments that are difficult, but not impossible, to reverse, what determines the dynamics of commitment and reversal? The assumption of once-and-for-all choice enforces simplistic dynamics on the policy process; if the standard models are interpreted literally, for example, the commitment problem for U.S. monetary policy is moot, having been resolved with the founding of the Federal Reserve System in 1914, if not at the Constitutional Convention of 1789. Much of the interest in dynamic inconsistency, however, arises pre

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