Explain the Time-Inconsistency Problem

question 38

Essay

Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?

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Definitions:

Macaulay Duration

A measure of the weighted average time until a bond's cash flows are repaid, used in assessing interest rate risk.

Future Value

The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today, taking into account various factors like interest or returns.

Present Value

The current worth of a future sum of money or stream of cash flows given a specified rate of return.

Coupon Rate

The annual interest rate paid by a bond, expressed as a percentage of the bond's face value.