The time-inconsistency problem in discretionary policymaking about unemployment and inflation can be effectively avoided when the:
A) policymaker has and is known to have an extremely strong preference for very low inflation.
B) policymaker does not care about the rate of inflation and simply sets policy to avoid unemployment.
C) private agents in the economy are not "rational."
D) policymaker has more information than do the private agents in the economy.

Question

Quizplus · Accepted Answer

When the policymaker has and is known to have an extremely strong preference for very low inflation, private agents in the economy will anticipate this preference and will not expect the policymaker to deviate from this goal in the future. This eliminates the time-inconsistency problem that arises when the policymaker promises to keep inflation low in the future but has an incentive to renege on this promise in order to reduce unemployment in the short run.

The Time-Inconsistency Problem in Discretionary Policymaking About Unemployment and Inflation