Tuesday, December 7, 2010

Barack Obama's Time Consistency Problem?

When I explain the time-consistency problem to my students, I begin by asking them what the stated position of the government is about negotiating with hostage takers.  They know, of course, that the official line is that the government will not negotiate.

The reason why governments always say they will not negotiate with hostage takers is that, if they won't negotiate, there is no incentive to take them in the first place.  But, once hostages have been taken, the government has a strong incentive to negotiate because they don't want to be responsible for the hostages getting killed.  And the problem is that the would-be hostage takers understand this, and therefore do not believe the government will follow its announced policy of not negotiating.

That example may not work next semester, if my future students saw President Obama's press conference:

I’ve said before that I felt that the middle-class tax cuts were being held hostage to the high-end tax cuts.  I think it’s tempting not to negotiate with hostage-takers, unless the hostage gets harmed.  Then people will question the wisdom of that strategy.  In this case, the hostage was the American people and I was not willing to see them get harmed.  
One of the implications of the time consistency problem is that a better outcome would be achieved if the government didn't have discretion to negotiate with the hostage takers.  In the real world, no perfect "commitment technology" exists so, in practice, we think about "credibility".  That is, how can the government behave so that the prospective hostage takers believe the authorities really mean it when they say they won't negotiate?

So, the question is: did President Obama diminish his credibility, thereby increasing the likelihood of future political "hostage" situations, or did he just say what everyone already knows?  And was the Republican threat credible to kill the hostages let the tax code revert to its 2000 levels if the tax cut extension for incomes over $250,000 wasn't included?  (John Boehner's slip in September notwithstanding).

For background on time consistency and more examples, see Greg Mankiw, this speech by Charles Plosser, and the Nobel Prize information about Kydland and Prescott


Andy Harless said...

The Republican threat was certainly credible, because it was in their political interest to carry out the threat, given that Obama's reelection chances depend heavily on changes in aggregate demand between now and 2012. It's kind of like if the hostage is someone whom the hostage taker would like to kill anyway, and the only reason to let the hostage live is to get the ransom. There's not really any time inconsistency. If you repeat this game with same parameters and never pay the ransom, they'll still keep killing the hostage.

Corban said...

In the hostage situation, you need to turn the kill into public anger against the terrorists, so that their resources are threatened. To follow the analogy, Obama should not have conceded, but let the Republicans follow through with their threat...followed by tracing cause and effect back to them.

A person can be smart, but people are only average. That they cannot follow this chain is an indictment of the US right now.

Bill C said...

Thanks for the comments.

Andy - I wonder if that's essentially what the White House was thinking; and it implies Mitch McConnell really meant it when he said their goal is to prevent Obama from being relected. But, as you suggest, Corban, the Republican stance probably would have been unpopular and Obama may have failed to exploit this to get the best possible deal.

Allen said...

Obama made a terrible mistake. The public would not remember the tax issue in 2 years any more than the fact that Reconciliation was used in the health care vote or the gulf oil spill even both of these were said to have a huge impact on the election at the time. Obama could run on a tax cut if the public would just toss out those bad Republicans. Plus, people will notice the deficit. People will also notice the removal of the payroll tax cut, which will make the economy worse just in time for Obama to be defeated by Palin.