A person may think their own ways are right, but the Lord weighs the heart
Proverbs 21:2
What distinguishes human beings from other creatures and living things is the fact that human has common sense, logical and rational thinking as well as cognitive skills. Meanwhile, what distinguishes human beings from technologies, machines, and robots is the fact that human has emotion, empathy, and conscience. The combination of both facts influences human behaviors, preferences as well as decisions among various options and circumstances. This also brings out another issue in decision making, namely time inconsistency, in economic and psychological perspectives. The issue of time inconsistency, in the long run, would hinder someone or some institutions in accomplishing the objectives and targets established initially. While it may be appropriate to make decisions by using discretion adaptively as a response to certain situations, to some extent, it is also crucial to have several rules or commitments to avoid time inconsistency in order to keep on track to achieve a certain set of goals.
Time inconsistency fundamentally means that there is disagreement or contradiction between a decision maker’s different selves regarding decisions and actions to be taken. Furthermore, in the behavioral economics context, time inconsistency is associated with the way in which each different selves of decision-makers may have different preferences regarding current and future decisions. In other words, time inconsistency refers to a situation in which preferences of decision-makers change along the time such that some preferences could appear inconsistent with each other at some other point in time. An individual with time-inconsistent preferences tends to weigh the value of the present more than the future. As a result, he/she might make decisions with a present bias issue, and hence inclined to prefer the options that would make him/her happy at the moment. Thus, time inconsistency could be defined as the inability to consistently make decisions following a long-run target or plan over one’s lifetime.
Some Illustrations
There are numerous examples of time inconsistency, which will be discussed from economics and psychological contexts. From the economics example, time inconsistency might appear in both microeconomics e.g. behavioral economics, and macroeconomics e.g. central bank independence. Firstly, in behavioral economics, a study from Loewenstein and Prelec (1992) show that should people are given the following two choices: $500 today or $505 tomorrow, and $500 in a year or $505 in a year and one day, the time-consistent answer expected would be to choose either $500 in both cases or $505 in both cases. Nevertheless, the result reveals that many people would opt for $500 today for the first choice and $505 in a year and one day for the second choice, from the present time. This combination of decisions reflects time inconsistency since both choices include precise discrepancies, that are $5 and one day, and hence it is supposed to have the same choice irrespective of time.
The time inconsistency, in this case, might occur since these people discount the benefits of choices progressively with time. In other words, some people tend to put less value on the benefits of a choice that gets far in the future. This condition indicates the so-called immediacy effect or temporal discounting, which refers to the view that the present time has a chiefly high value in comparison to any point of time in the future. As a result, someone would not pay equivalent attention to the present and the future self. In addition, time inconsistency further might associate with various daily topics such as procrastination, addiction, efforts at weight loss, and pension fund.
Another source of time inconsistency in the context of behavioral economics is the sentiments associated with past and future experiences which could be perceived as individual natural discounting mechanisms and hence making it more sensitive to distant future rewards and penalties in selected events. Further, miscalculation and competition for limited resources that forces some people to think that it is better to act now because the opportunity may not be available tomorrow could also lead to inconsistent behavior. In addition, personal mindset or orientation and priority concerning the future or the present, for instance, doing the right thing rather than willingness, also contributes to inconsistent behavior over time.
Secondly, in the macroeconomics context, Kydland and Prescott (1977) suggest that monetary policymakers struggle with time (dynamic) inconsistency in terms of inflation expectations. They argue that the central bank as a monetary policymaker should be independent to avoid the problem of time inconsistency. As an illustration, politicians, particularly in the period of the national election, probably have the best campaign promise to keep low inflation in the future. Nevertheless, when the future comes, lowering inflation may have its downside, such as increasing unemployment, and hence they are inclined to do less attempt in accordance with their initial promise. This means that they do other actions based on people’s responses after the announcement of their policy or covenant for certain reasons. In most cases, time inconsistency of political acts evokes due to the costs and benefits of policies and institutional changes emerging at different times.
Blejer and Nagy-Mohacsi (2017) explain that populist politicians are aware of the costs of their promises and policies, however, they may have agenda to gain and maintain power regardless of the costs, distract the focus to hold their covenants and hence lower their intention to pay for the consequences. In order to address this time inconsistency issues, macroeconomic policy-making circles in numerous states have shifted towards the mandate of inflation targeting and central bank independence as solutions. This raises the notion of an independent policymaker (central banks) as it is believed to be advantageous for an economy to keep its performance on track to the target established, without the intervention of any kind of political interest. A time-inconsistent policy might please the society in the short run but would eventually fail to achieve the long-run policy objective. On the contrary, a time-consistent policy, set and hold to the long-run policy objective yet might not be popular for the public in the short run.
The micro and macroeconomics example above could be connected to each other since the subject is a human being by incorporating the two types of time inconsistency, namely intra-personal time inconsistency and inter-personal time inconsistency (Baddeley, 2019). Intra-personal time inconsistency in behavior economics could be explained as the outcome of intra-personal strive between different selves at different times (Frederick et. al, 2002). Intra-personal time inconsistency manifest in present bias and preference reversals. As an example, when an individual is planning for a further time in the future regarding relationship or partnership, he/she might be confident to face any challenge and risk, as well as believe in the capability of resisting temptation at the time he/she makes the plan, but when temptation and struggle become real, more immediate and tangible, they respond by changing their preferences which reflect the inability to persist the temptation, which could also be linked with the immediacy effect mentioned before. Moreover, Frederick et. al (2002) and other experimental evidence from psychological and behavioral economic studies agree that individuals’ time preference rate is unstable and dynamic, and hence the intra-personal time inconsistency is reflected in the shifts in an individual’s rate of time preference depending on the time period in which he/she manages the available options. The intra-personal time inconsistency might further magnify the problem of inter-personal time inconsistency – which involves other parties or entities outside of an individual e.g. institutions – and creates the issue of present bias, i.e. an unequal concern on short-term rewards and a mismatch between long-run intentions and short-run actions that could explain the dynamic strategic interactions between policymakers and private agents in the macroeconomy.
Furthermore, another intriguing facet regarding time inconsistency comes from the competing interest of the ‘should’ self and the ‘want’ self (Rogers and Bazerman, 2008). In certain situations, each individual may confront a dilemma between the deliberative ‘should’ self and an affective ‘want’ self in decision making. These faces of oneself might contribute to the time inconsistency of an individual. Rogers and Bazerman (2008) show that people are more probable to select options that provide the ‘should’ self, i.e. the option that he/she should do when the choices will be applied in the distant rather than the near future. Put this ‘should’ self in policymaking context, it is suggested that it will have a sort of policy design and decisions which could have systematic behavioral consequences that would improve welfare, vice versa. Meanwhile, the ‘want’ self might bring comfort and pleasure in the present moment but not necessarily in the future, and this might be the reason for the spontaneity or impulsive traits in making decisions when one does not apply a proper and sufficient consideration before deciding actions.
What Could Be Done?
From the examples of time inconsistency given above, it could be inferred some solutions in regards to the issue. First, from both micro and macro perspectives, individuals, as well as institutions, might need to hold commitment with respect to each of their goals. With the presence of commitment in any kind as a reinforcement attempt and device, beliefs might become more optimistic over time, people might be more likely to keep on track in acting or thinking in such a way that allows them to achieve what is aimed, and people properly show a preference for commitment which in turn leads to a more time-consistent behavior (Brunnermeier, Papakonstantinou and Parker, 2016). Recalling the initial commitment could also play a role as fuel for an individual to be persistent in times of temptation. Moreover, for institutions, well-designed institutions could contribute to overcoming time-inconsistency problems when they are equipped with behavioral macroeconomic policy solutions such as effective commitment mechanisms for policymakers, e.g. long-term contracts to reinforce and supervise the behavior of the institutions with their ultimate objectives.
Second, from the macro perspective, policymakers, in particular, might have to make credible rules. Ergo, to some extent and for some institutions e.g. central bank, it might necessary to be independent in terms of designing and making policies, and have credible rules. Kydland and Prescott (1977) highlight the importance of balancing not only the desirable and popular policy to handle a given set of circumstances but also the framework which is more likely to produce the best (or second-best) policy over time. Credible rules are crucial to gain trust between public and private sectors in order to keep them operating in such a manner to reduce the probability that either party will fail to hold on to their predetermined commitments. For instance, in the case of the state budget, a balanced-budget rule might be considered to keep the economy from the debt ceiling crisis. Following up this rule by applying derivative credible rules, e.g. enforcement of a strict private credit limit and a local government debt ceiling that could not be increased would force people to commit to certain actions in accordance with the rule. Meanwhile, in individual level, personal credible rules could play a role as guidance containing predefined action/plan for a given situation, e.g. a daily budget cashflow, budget allocation, and cash-only rule or a credit card with a low-level spending limit might act as prevention from spending money extravagantly and wisely manage private finance. It is expected that by using credible rules, they (individuals and institutions) will behave in a more time-consistent manner.
In conclusion, there is a well-known phrase that says time is relative. It should be noted either that human being is dynamic living creatures, in terms of acting and thinking. An individual is relative in the face of time, circumstances, and the surrounding environment. Individuals and institutions set their objectives and might make decisions that align with their intentions, however, some circumstances may place people and institutions in periods where they act inconsistently with the initial goals. Therefore, reinforcement and guidance are needed to cope with struggle and temptation in order to accomplish the ultimate objectives. This post is intended to tell that individuals, as well as institutions, might need some principle and commitment as guidance in making decisions to accomplish objectives established. Being adaptive to the circumstance is a necessity in order to survive in a time of struggle, yet commitment and principle could be a fundamental and useful postulate to keep consistent since consistency is a key.
References
Beljer, M. and Nagy-Mohacsi, P. (November 22, 2017). Populism and time inconsistency. Vox EU CEPR
Baddeley, M. (July 19, 2019). Behavioural Macroeconomic Policy: New perspectives on time inconsistency. Retrieved 12 September 2020 from https://arxiv.org/pdf/1907.07858.pdf
Brunnermeier, M, Papakonstantinou, F. and Parker, J. (2016). Optimal Time-Inconsistent Beliefs: Misplanning, Procrastination, and Commitment. Management Science
Buol, J and Vaughan, M. (January 1, 2003). Rules vs. Discretion: The Wrong Choice Could Open the Floodgates. Federal Reserve Bank of St. Louis
Frederick, S., Loewenstein, G. and O’Donoghue, T. (2002). Time discounting and time preference: A critical review. Journal of Economic Literature, XL:351–401
Kedzia, L. (January 2018). The Concept of Time Inconsistency. EDHEC Stundent Finance Club
Kydland, F. and Prescott, E. (1977). Rules Rather than Discretion: The Inconsistency of Optimal Plans. Journal of Political Economy. 85 (3): 473–492
Loewenstein, G.; Prelec, D. (1992). Anomalies in Intertemporal Choice: Evidence and an Interpretation. The Quarterly Journal of Economics. 107 (2): 573–597.
Rogers, T. and Bazerman, M. (2008). Future lock-in: Future implementation increases selection of ‘should’ choices. Organizational Behavior and Human Decision Processes, 106, 1–20
Taylor, J. (May 6, 2013). Time Inconsistency and Monetary Policy. https://web.stanford.edu/~johntayl/Spring2013PhDclass/6_Time_Inconsistency_and_Monetary_Policy
Vermann, E. (September, 2011). Time Inconsistency: Today’s Actions = Tomorrow’s Regrets. The Liber8 Economic Information Newsletter
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