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Abstract:
Due to time-inconsistency or policymakers' turnover, economic promises are not always fulfilled and plans are revised periodically. This fact is not accounted for in the commitment or the discretion approach. We consider two settings where the planner occasionally defaults on past promises. In the first setting, a default may occur in any period with a given probability. In the second, we make the likelihood of default a function of endogenous variables. We formulate these problems recursively, and provide techniques that can be applied to a general class of models. Our method can be used to analyze the plausibility and the importance of commitment and characterize optimal policy in a more realistic environment. We illustrate the method and results in a fiscal policy application.
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