The Optimal Timing of Institutional Reform in a Dynamic Optimization Framework

Danyang Xie and Heng-Fu Zou ()

No 792, CEMA Working Papers from China Economics and Management Academy, Central University of Finance and Economics

Abstract: We study the optimal timing of institutional reform in a growth model where reform is anticipated and causes a one-time disruption. Institutions are costly tech- nologies that affect the economy's resource constraint and household saving. We solve for the optimal reform time by maximizing lifetime utility within a continuous-time optimal control framework with an endogenous switching time. For an analytically tractable case, we derive the necessary conditions for an optimal interior reform time. The core condition is the continuity of the optimized Hamiltonian at the point of reform, solved simultaneously with jump conditions for capital and its shadow price. This approach internalizes the fact that the pre-reform path is chosen in anticipation of the reform date. A calibration exercise illustrates three distinct regimes: immediate reform, delayed reform, and indefinite postponement, depend ing on the magnitude of the disruption and the quality of institutional improvement. Our analysis yields policy implications for sequencing and communicating reforms, highlighting conditions under which delay is optimal even when new institutions are unambiguously superior in the long run.

Pages: 15 pages
Date: 2025-10-22
New Economics Papers: this item is included in nep-gro
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