Dynamic Inconsistency, Rational Expectations, and Optimal Government Policy
James M. Malcomson
The consensus in the literature is that the use of only lump-sum taxation is a necessary and sufficient condition for the dynamic consistency of optimal open-loop government policies. We show that this does not hold for models with nonhomogeneous agents. Then the stated condition is neither necessary nor sufficient. Dynamic inconsistency arises because of a shortage of appropriate government policy instruments which amounts to the consensus condition only in special cases.