Endogenous Punishment and Time Inconsistency
Date Issued
2010
Date
2010
Author(s)
Huang, Hui-Chung
Abstract
Based on the model developed by Barro and Gordon (1983b), this thesis sets up a time inconsistency model featuring endogenous punishment. Specifically, this thesis assumes that monetary policy is delegated to a central banker whose preferences are the same as the representative agent, and addresses how the endogenous punishment mechanism will affect the decision of the central banker when the government office terms are finite. Then, this thesis deals with how the government chooses the optimal punishment weight to maximize the social welfare level. Finally, by means of numerical simulations, this thesis analyzes how the values of relevant exogenous parameters influence the optimal punishment weight chosen by the government.
Our analysis finds that the introduction of endogenous punishment would lead to a reduction of the average inflation rate at the cost of a rise in the variability of output. In addition, to maximize the social welfare level, our numerical simulations show the following results: (1) the optimal punishment weight selected by the government is negatively related to the discount factor and the variability of shock; (2) the optimal punishment weight chosen by the government has a positive relationship with the sacrificed ratio, the extent of social distortion, and the extent placed by the central banker on inflation stabilization relative to output stabilization.
Subjects
Time inconsistency
Endogenous punishment
Inflation bias
Type
thesis
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