This article characterizes optimal policy when a government uses indirect control to exert its authority. We develop a dynamic principal-agent model in which a principal (a government) delegates the prevention of a disturbance–such as riots, protests, terrorism, crime, or tax evasion–to an agent who has an advantage in accomplishing this task. Our setting is a standard repeated moral hazard model with two additional features. First, the principal is allowed to exert direct control by intervening with an endogenously determined intensity of force which is costly to both players. Second, the principal suffers from limited commitment. Using recursive methods, we derive a fully analytical characterization of the intensity, likelihood, and duration of intervention. The first main insight from our model is that repeated and costly equilibrium interventions are a feature of optimal policy. This is because they are the most efficient credible means for the principal of providing incentives for the agent. The second main insight is a detailed analysis of a fundamental trade-off between the intensity and duration of intervention which is driven by the principal's inability to commit. Finally, we derive sharp predictions regarding the impact of various factors on the optimal intensity, likelihood, and duration of intervention. We discuss these results in the context of some historical episodes.

This article develops a model of optimal government debt maturity in which the government cannot issue state-contingent bonds and cannot commit to fiscal policy. If the government can perfectly commit, it fully insulates the economy against government spending shocks by purchasing short-term assets and issuing long-term debt. These positions are quantitatively very large relative to GDP and do not need to be actively managed by the government. Our main result is that these conclusions are not robust to the introduction of lack of commitment. Under lack of commitment, large and tilted debt positions are very expensive to finance ex ante since they exacerbate the problem of lack of commitment ex post. In contrast, a flat maturity structure minimizes the cost of lack of commitment, though it also limits insurance and increases the volatility of fiscal policy distortions. We show that the optimal time-consistent maturity structure is nearly flat because reducing average borrowing costs is quantitatively more important for welfare than reducing fiscal policy volatility. Thus, under lack of commitment, the government actively manages its debt positions and can approximate optimal policy by confining its debt instruments to consols.