Time-consistently undominated policies

Working paper

This paper proposes and characterises a new normative solution concept for Kydland and Prescott problems, allowing for a commitment device. A policy choice is dominated if either (a) an alternative exists that is superior to it in a time-consistent subdomain of the constraint set, or (b) an alternative exists that Pareto-dominates it over time. Policies may be time-consistently undominated where time-consistent optimality is not possible. We derive necessary and sufficient conditions for this to be true, and show that these are equivalent to a straightforward but significant change to the first-order conditions that apply under Ramsey policy. Time-consistently undominated policies are an order of magnitude simpler than Ramsey choice, whilst retaining normative appeal. This is illustrated across a range of examples.

Authors: Ellison, M; Brendon, C

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2018-01-31
• Paper number: 844
• Keywords: Ramsey policy; undominated policy; time consistency