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SOCIAL CHOICE AND TIME CONSISTENCY WITH LOW-PROBABILITY EVENTS

Published online by Cambridge University Press:  06 June 2016

Claudio A. Bonilla*
Affiliation:
University of Chile
*
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.

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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Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

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.

References

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

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