By Arnold Kling
Time consistency is one of those terms that economists throw around, and it has come up several times recently on this blog. It might be worth defining/explaining.
The situation arises when someone makes a commitment to take an action in the future. If the incentive to keep the commitment is the same as the incentive to make the commitment, then the example is time consistent. However, if the incentive to keep the commitment is significantly less than the incentive to make the commitment, then we say that the example is time-inconsistent or that there is a time-consistency problem.
For example, when I refinance a mortgage, I make a commitment to pay back the new loan in the future. Consider two cases.
1. I borrow $100,000 against my primary residence, which has a value of $200,000.
2. I borrow $400,000 against an investment property, which has a value of $200,000.
In case (1), my incentive to keep the commitment is not really any weaker than my incentive to make the commitment. There is no time consistency problem. In case (2), I have a strong incentive to make the commitment but only a weak incentive to keep the commitment. There is a time consistency problem.
If you make a commitment to go on a diet, starting tomorrow, there is a time consistency problem. Tomorrow when you go to a party and they serve chocolate cake, your incentive to keep your commitment will be weaker than today’s incentive to make that commitment.
A bank regulator has an incentive to make a commitment to not bail out banks. By making this commitment, the regulator puts pressure on the market to control risk taking. However, when a failure occurs, the regulator often feels pressure to do the bailout. Thus, there is a time consistency problem.
Congress has an incentive to make a commitment to take future actions to reduce the deficit, such as cutting Medicare payments to doctors. However, when the time comes, the incentive will be to avoid painful cuts, as Bryan and many others have pointed out.
Health care legislation that is financed by future cuts in Medicare represents a classic time inconsistency problem.