Parenting and a Nobel Prize

Two ideas are the centerpiece of this year's Nobel Prize in economics: time inconsistency and real business cycle models. There are a lot of discussions of the policy implications of these ideas, but few of their wider import. Let me show you the beauty of time inconsistency here with a non-economic example.

Time inconsistency is often discussed in terms of the decisions of policymakers, but it is also fundamental to good parenting. Who knew? (Well economists did of course.)

How is this so? The basic idea of time inconsistency is that a decision that is good at one point if often changed at a later time when it isn't good any more. The rub is that the change in decision makes it unlikely that anyone will pay attention the next time around if you make the first decision. They know you reneged once, and that you'll probably do so again.

Parents and kids do this all the time. Parents make decisions that are optimal. For example, deciding that bed time will be 9 P.M. But then, bed time rolls around and everyone is having a good time, and it no longer seems like such a good idea to send the kids to bed. The parents renege, and the kids stay up.

The beauty of the time inconsistency idea set forth so brilliantly by Kydland and Prescott in 1977 is not that either of those decisions is wrong in and of themselves, but recognizing that the second choice makes a repeat of the first choice non-credible. If the parents set the same bed time the next night, the kids will not take it seriously. So, the process of reneging once sets up a vicious cycle of empty decisions and non-credible statements. And, if you try to change that system, the parents end up looking arbitrary and capricious.

Now think about the good parents and good kids that you know. The parents typically set up credible rules that they follow through on them. And the kids may complain about the quantity or quality of rules, but they always like their parents to be fair and uncapricious.

Kydland and Prescott's insight was that optimal decision making isn't enough. Decisions need to be credible too, and therefore linked through time in a fundamental and intelligent way.

Comments

[chester white]

THAT is worth a Nobel Prize? Geeeez.

[Dave Tufte]

Well ... I said that I was interpreting this into an example that non-economists could grasp. Kydland and Prescott's results are much more far reaching about how "benevolent" governments should act.