This article studies optimal relational contracts when the value of the relationship between contracting parties is not commonly known. I consider a principal-agent setting where the principal has persistent private information about her outside option. I show that if the principal has the bargaining power, she wants to understate her outside option to provide strong incentives and then renege on promised payments, while if the uninformed agent has the bargaining power, the principal wants to overstate her outside option to capture more surplus. I characterize how information is revealed, how the relationship evolves, and how this depends on bargaining power. (JEL C78, D82, D83, D86)

We study rules based on instruments versus targets. Our application is a New Keynesian economy where the central bank has non-contractible information about aggregate demand shocks and cannot commit to policy. Incentives are provided to the central bank via punishment which is socially costly. Instrument-based rules condition incentives on the central bank’s observable choice of policy, whereas target-based rules condition incentives on the outcomes of policy, such as inflation, which depend on both the policy choice and realized shocks. We show that the optimal rule within each class takes a threshold form, imposing the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the central bank’s information is sufficiently precise, and they are relatively more attractive the less severe the central bank’s commitment problem. The optimal unconstrained rule relaxes the instrument threshold whenever the target threshold is satisfied.

We study a fiscal policy model in which the government is present‐biased towards public spending. Society chooses a fiscal rule to trade off the benefit of committing the government to not overspend against the benefit of granting it flexibility to react to privately observed shocks to the value of spending. Unlike prior work, we examine rules under limited enforcement: the government has full policy discretion and can only be incentivized to comply with a rule via the use of penalties which are joint and bounded. We show that optimal incentives must be bang‐bang. Moreover, under a distributional condition, the optimal rule is a maximally enforced deficit limit, triggering the maximum feasible penalty whenever violated. Violation optimally occurs under high enough shocks if and only if available penalties are weak and such shocks are relatively unlikely. We derive comparative statics showing how rules should be calibrated to features of the environment.

This paper studies the optimal level of discretion in policymaking. We consider a fiscal policy model where the government has time-inconsistent preferences with a present bias toward public spending. The government chooses a fiscal rule to trade off its desire to commit to not overspend against its desire to have flexibility to react to privately observed shocks to the value of spending. We analyze the optimal fiscal rule when the shocks are persistent. Unlike under independent and identically distributed shocks, we show that the ex ante optimal rule is not sequentially optimal, as it provides dynamic incentives. The ex ante optimal rule exhibits history dependence, with high shocks leading to an erosion of future fiscal discipline compared to low shocks, which lead to the reinstatement of discipline. The implied policy distortions oscillate over time given a sequence of high shocks, and can force the government to accumulate maximal debt and become immiserated in the long run.

Governments are present-biased toward spending. Fiscal rules are deficit limits that trade off commitment to not overspend and flexibility to react to shocks. We compare coordinated rules, chosen jointly by a group of countries, to uncoordinated rules. If governments’ present bias is small, coordinated rules are tighter than uncoordinated rules: individual countries do not internalize the redistributive effect of interest rates. However, if the bias is large, coordinated rules are slacker: countries do not internalize the disciplining effect of interest rates. Surplus limits enhance welfare, and increased savings by some countries or outside economies can hurt the rest. (JEL D82, E43, E62, H62)

We propose a political economy mechanism that explains the presence of fiscal regimes punctuated by crisis periods. Our model focuses on the interaction between successive deficit-biased governments subject to independently and identically distributed fiscal shocks. We show that the economy transitions between a fiscally responsible regime and a fiscally irresponsible regime, with transitions occurring during crises when fiscal needs are large. Under fiscal responsibility, governments limit their spending to avoid transitioning to fiscal irresponsibility. Under fiscal irresponsibility, governments spend excessively and precipitate crises that lead to the reinstatement of fiscal responsibility. Regime transitions can occur only if governments’ deficit bias is large enough.

A principal faces an agent who is better informed but biased toward higher actions. She can verify the agent’s information and specify his permissible actions. We show that if the verification cost is small enough, a threshold with an escape clause (TEC) is optimal: the agent either chooses an action below a threshold or requests verification and the efficient action above the threshold. For higher costs, however, the principal may require verification only for intermediate actions, dividing the delegation set. TEC is always optimal if the principal cannot commit to inefficient allocations following the verification decision and result.

We present a novel theory of the employment relationship. A manager can invest in attention technology to recognize good worker performance. The technology may break and is costly to replace. We show that as time passes without recognition, the worker's belief about the manager's technology worsens and his effort declines. The manager responds by investing, but this investment is insufficient to stop the decline in effort and eventually becomes decreasing. The relationship therefore continues deteriorating, and a return to high performance becomes increasingly unlikely. These deteriorating dynamics do not arise when recognition is of bad performance or independent of effort. (JEL D21, D82, J24, M54)

A principal incentivizes a team of agents to work by privately offering them bonuses contingent on team success. We study the principal’s optimal incentive scheme that implements work as a unique equilibrium. This scheme leverages rank uncertainty to address strategic uncertainty. Each agent is informed only of a ranking distribution and his own bonus, the latter making work dominant provided that higher-rank agents work. If agents are symmetric, their bonuses are identical. Thus, discrimination is strictly suboptimal, in sharp contrast with the case of public contracts (Winter 2004). We characterize how agents’ ranking and compensation vary with asymmetric effort costs. (JEL D23, D62, D81, D82, D86)

A firm raises capital from multiple investors to fund a project. The project succeeds only if the capital raised exceeds a stochastic threshold, and the firm offers payments contingent on success. We study the firm’s optimal unique-implementation scheme, namely the scheme that guarantees the firm the maximum payoff. This scheme treats investors differently based on size. We show that if the distribution of the investment threshold is log-concave, larger investors receive higher net returns than smaller investors. Moreover, higher dispersion in investor size increases the firm’s payoff. Our analysis highlights strategic risk as an important potential driver of inequality. (JEL D21, D86, G24, G32)