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SOCIAL CHOICE AND TIME CONSISTENCY WITH LOW-PROBABILITY EVENTS

  • Claudio A. Bonilla (a1)

Abstract

A key result in macroeconomics is the “time inconsistency of short-run optimal plans.” It is argued that inflationary bias results if central bankers do not precommit to a monetary policy rule. The macro literature, however, does not address the way in which board members arrive at the “optimal choice of inflation rate.” That is a matter of a micro subfield called social choice. If we consider that on any board, members have different priors about the states of nature for the economy, but they all receive the same signal before deciding, then they will have different posterior probabilities for the states, even if they have many data, if one state has a low probability of occurring, such as an unlikely catastrophic-risk event. Thus, it is not clear what the optimal plan is. Therefore, discretion rather than rules may be the optimal plan in social choice settings.

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Corresponding author

Address correspondence to: Claudio A. Bonilla, School of Economics and Business, University of Chile, Diagonal Paraguay 257, Suite 1905, Santiago de Chile, Chile; e-mail: cbonilla@fen.uchile.cl.

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This paper originated from conversations between the author and Mel Hinich, and it can be considered a continuation of Melvin Hinich (2003), Risk when some states are low probability events. Macroeconomic Dynamics 7, 636–643. I am heavily in debt to Mel for his friendship and guidance. Mel rests in peace.

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References

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Albonico, Alice and Rossi, Lorenza (2015) Policy games, distributional conflicts and the optimal inflation. Macroeconomic Dynamics 19 (6), 12611293.
Arrow, Kenneth (1963) Social Choice and Individual Values, 2nd ed. New York: Wiley.
Aumann, Robert (1976) Agreeing to disagree. Annals of Statistics 4, 12361239.
Baxa, Jaromir, Roman, Horvath, and Vasicek, Borek (2014) Does monetary policy change? Evidence on inflation targeting countries. Macroeconomic Dynamics 18, 593630.
David, Hernert and Nagajara, H. (2004) Order Statistics. New York: John Wiley
Hinich, Melvin (2003) Risk when some states are low probability events. Macroeconomic Dynamics 7, 636643.
Kirman, Alan (1992) Whom or what does the representative individual represent? Journal of Economics Perspectives 6 (2), 117136.
Kydland, Finn and Prescott, Edward (1977) Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy 85 (3), 473491.
Lucas, Robert (1976) Econometric policy evaluation: A critique. In Brunner, K. and Meltzer, A. (eds.), The Phillips Curve and Labor Markets, Carnegie–Rochester Conference Series on Public Policy 1, pp. 1946. New York: American Elsevier.

Keywords

SOCIAL CHOICE AND TIME CONSISTENCY WITH LOW-PROBABILITY EVENTS

  • Claudio A. Bonilla (a1)

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