Econometrica: Mar 2006, Volume 74, Issue 2

Commitment vs. Flexibility
p. 365-396

Manuel Amador, Iván Werning, George‐Marios Angeletos

We study the optimal trade‐off between commitment and flexibility in a consump‐ tion–savings model. Individuals expect to receive relevant information regarding tastes and thus they value the flexibility provided by larger choice sets. On the other hand, they also expect to suffer from temptation, with or without self‐control, and thus they value the commitment afforded by smaller choice sets. The optimal commitment problem we study is to find the best subset of the individual's budget set. This problem leads to a principal–agent formulation. We find that imposing a minimum level of savings is always a feature of the solution. Necessary and sufficient conditions are derived for minimum‐savings policies to completely characterize the solution. We also discuss other applications, such as the design of fiscal constitutions, the problem faced by a paternalist, and externalities.

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Supplemental Material

Supplementary Material for Commitment vs. Flexibility

This supplementary document collects two results. First, we cover some findings regarding the possibilities for money burning with three types. Second, we present a result on how simple minimum savings allocations can be improved upon if Assumption A in the paper fails.

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Supplementary Material for Commitment vs. Flexibility

This Matlab code is only directly used and discussed in detail in Section 1 of the supplementary note, which in turn supports a claim made towards the end of Section 3.1 in the paper. The issue is the optimality of money burning in a version of the model with three types. As discussed in the supplementary note, the Matlab code solves the model with three types and produces a figure with the optimal allocation. The optimal allocation is shown as a function of the middle type's probability for regions where money burning is optimal. In particular, Figure 1 in the supplement was produced by this code, and illustrates a case where money burning is optimal for intermediate values of the middle type's probability.

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