Delayed Stabilization

Basic Idea
• When no single individual or interest group controls policy at a given
time, interactions among policymakers can produce inefficient
deficits.
• Each policymaker or interest group delays agreeing to fiscal reform in
the hope that others will bear a larger portion of the burden.

Example Case: Hyperinflation

Delayed Stabilization

Choosing to delay reformation because it is costly to do so.

It may improve the groups expected outcome, but as a
replacement, overall economic situation will be worsen.
Alesnia and Drazen 1991
• Fiscal reform must be undertaken, and that the
burden of the reform will be distributed
asymmetrically between two interest groups.

• Each group intends give the larger share of the

burden to the other group.
Hsieh (2000): Assumption

• Two Groups: Capitalists and Workers

• Must decide whether to reform fiscal policy and how to
divide the burden.
• No reform = Zero Payoff for both groups
Hsieh (2000): Assumption
If there is reform:
a. Capitalist: Receive pretax income (R)
b.Workers: Receive pretax income (W>0)
c. The amount (T) of taxes will be levied. (0 < T < W)
d.X denote as the amount of taxes paid by capitalists.
Then, after-tax income will be R-X for capitalists and (W-T)+X
for workers.
Hsieh (2000): Assumption

• R is random and the realization only known to capitalists.

• R is distributed some interval [A,B] where B ≥ A ≥ 0.
• R cannot be less than A.
Hsieh (2000): Model

• Workers make proposal concerning X to the capitalists.

• Fiscal policy is reformed when the proposal is accepted.
• Both capitalists and workers have the objective to
maximaizing their after-tax income.
• Capitalists will accept the proposal when R-X > 0.
Hsieh (2000): Model

Probability of proposal acceptance:

Hsieh (2000): Model

• Workers Expected Payoff: V(X)=P(X)[(W-T)+X]

• Substituting P(X), then we’ll have:
Hsieh (2000): Model

Two possibilities:
a. The workers may choose a value of X in the interval of [A,B],
so the probability of the proposal acceptance is between 0
and 1.
b.Since the lowest possible value of R is A, then workers will
choose X=A.
Hsieh (2000): Model

Workers Behaviour: take the derivative of V(X) w.r.t X,

a. If V’(X) is negative at X=A, in this case, wokeres propose X=A.

It occurs when [B-(W-T)]-2A is negative.
b.If V’(X) positive at X=A, the optimum defined by the
condition V’(X)=0. It occurs when [B-(W-T)]-2X=0
Hsieh (2000): Model
a. If V’(X) is negative at X=A, in this case, wokeres propose X=A.
It occurs when [B-(W-T)]-2A is negative.
b.If V’(X) positive at X=A, the optimum defined by the
condition V’(X)=0. It occurs when [B-(W-T)]-2X=0
So then we have,
Hsieh (2000): Model

The probability of the acceptance at X* is:

Workers’ expected payoff as a function
of their proposal

Panel (a):

Expected payoff is decreasing

over the entire range [A,B],
So that the workers propose
X=A
Workers’ expected payoff as a function
of their proposal

Panel (b):

Expected payoff is first increasing

and then decreasing over the
range [A,B],
So that the workers propose
strictly within range.