Dynamic inconsistency, tradeoffs and delegation

Abstract

Strategic interaction between the government and economic agents can lead to the creation of more populism than is socially optimal. The tradeoffs through which this occurs, important for a populous democracy with a large number of poor, is that between populism and growth. This has not received much analytical attention. We model this tradeoff and show that (i) a Nash equilibrium will occur with a level of populism higher than the optimal, (ii) define a sustainable rate of growth, (iii) specify the conditions on which the results depend, (iv) discuss stabilisation possibilities, and (v) show that optimal delegation is to a pro-growth monetary authority and a conservative fiscal authority. This would lower populism and in inflation while keeping growth at sustainable levels. Last, the model is used to interpret Indian macroeconomic performance.