Dynamic Inconsistency <Back to Last Page>     <Full Glossary>

Definition of Dynamic Inconsistency: A possible attribute of a player's strategy in a dynamic decision-making environment (such as a game).

When the best plan that a player can make for some future period will not be optimal when that future period arrives, the plan is dynamically inconsistent.

In one stylized example, addicted smokers face this problem -- each day, their best plan is to smoke today, and to quit (and suffer) tomorrow in order to get health benefits subesquently. But the next day, that is once again the best plan, so they do not quit then either. (In a model this can come about if the planner values the present much more than the near future, -- that is, has a low short-run discount factor -- but has a higher discount factor between two future periods.)

Monetary policy is sometimes said to suffer from a dynamic inconsistency problem. Government policymakers are best off to promise that there will be no inflation tomorrow. But once agents and firms in the economy have fixed nominal contracts, the government would get seigniorage revenues from raising the level of inflation. (Econterms)

Terms related to Dynamic Inconsistency:

• Seigniorage

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