14th journées Louis-André Gérard-Varet

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Listen to the market, hear the best policy decision, but don't always choose it.
David Aaron Reinstein, Joon Song

Last modified: 2015-05-11

Abstract


Policymakers must often decide whether to pursue a policy that has uncertain benets. The

response of asset markets to proposed policy changes can be a valuable source of information

for policy-setting. However, policymakers must take into account that an informed trader may

anticipate this and protably manipulate the market. We show that it is optimal for policymakers

to listen to asset markets, but they must commit (e.g., through ``political capital'') to sometimes

pursuing a policy even when the expected welfare eects are negative. Surprisingly, allowing traders

to short-sell can make it easier for policymakers to induce truth-telling actions.


Keywords


Policymaking, policy markets, information and prediction markets, mechanism design, indirect mechanisms, asymmetric information, regulation, event studies, political economy, random intervention, commitment, transparency.