Optimal Pre-commitment in Macro-economic Policy: A Game Theoretic Analysis of Fiscal Policy

Martin Evans

Oxford Economic Papers, 1990, vol. 42, issue 4, 695-714

Abstract: This paper proposes a new solution to the problem of time inconsistency that arises in dynamic policy games played between the government and the public. In a Stackelberg game, a subgame-perfect equilibria is found in which members of the public employ trigger strategies in response to a sequence of policies chosen by the government. The government's precommitment to a particular policy is determined endogenously as part of its optimal strategy. In a simple political model of fiscal policy, the proposed equilibrium is used to show why a government will tolerate a rise in debt well above its targeted level. Copyright 1990 by Royal Economic Society.

Date: 1990
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