Dynamic inconsistency, cooperation and the benevolent dissembling government

Abstract The paper investigates the circumstances under which the problem of dynamic inconsistency arises, and discusses its implications for control theory and optimal policy-making. The problem arises when the government does not have non-distortionary control instruments at its disposal and when expectations of future variables are relevant to current private sector decisions. It can also arise if the policy maker's utility function differs from that of the representative individual. The problem may disappear if cooperative behavior can be induced. The problem does not preclude the use of optimal control theory in economic policy analysis, but raises serious issues about the types of optimal control paths that are most relevant for policy-making.