Rules versus Discretion without Common Knowledge

This paper revisits the classical time inconsistent problem à la Barro and Gordon (1983) while relaxing the common knowledge assumption. When information is complete, achieving the first-best outcome is not possible, and the welfare under committed rules surpasses that under discretionary policies. In contrast, without common knowledge, a policymaker adhering to committed rules can always attain the first-best outcome. If a commitment device is unavailable, the resulting welfare loss can either increase or decrease relative to the common-knowledge benchmark.