Time Inconsistency
Time inconsistency is when a plan that is optimal to announce today is not optimal to carry out tomorrow, so promises without commitment are not believed.
Definition
Kydland–Prescott (1977) and Barro–Gordon: a discretionary policymaker wants to promise low inflation, then inflate to cut unemployment. Rational agents anticipate this, so you get inflation without the employment gain. Commitment (rules, independent CBs, contracts) is the fix.
Why it matters
Forward guidance, ‘transitory,’ and ‘we will not bail out X’ are time-consistency problems. If the future self has a different incentive, the market prices the deviation now.
Case
1970s inflation bias is the textbook case. Bank-resolution promises that die on a Sunday night (Credit Suisse AT1, 2023) are the financial version.
How to read it
Ask what the future self wants and whether anyone can punish deviation. Cheap talk is not a reaction function.
Key papers
Landmark references with real publisher or arXiv links — not token-overlap noise.
- Rules Rather than Discretion: The Inconsistency of Optimal PlansKydland, Prescott · 1977 · Journal of Political EconomyThe time-inconsistency paper.