July 2016
I study the problem of a government with low credibility, who decides to make a reform to remove ex-post time inconsistent incentives due to lack of commitment. The government has to take a policy action, but has the ability to commit to limiting its discretionary power. If the public believed the reform solved this time inconsistency problem, the policy maker could achieve complete discretion. However, if the public does not believe the reform to be successful, some discretion must be sacrificed in order to induce public trust. With repeated interactions, the policy maker can build reputation about her reformed incentives. However, equilibrium reputation dynamics are extremely sensitive to assumptions about the publics beliefs, particularly after unexpected events. To overcome this limitation, I study the optimal robust policy that implements public trust for all beliefs that are consistent with common knowledge of rationality. I focus on robustness to all extensive-form rationalizable beliefs and provide a characterization. I show that the robust policy exhibits both partial and permanent reputation building along its path, as well as endogenous transitory reputation losses. In addition, I demonstrate that almost surely the policy maker eventually convinces the public she does not face a time consistency problem and she is able to do this with an exponential arrival rate. This implies that as we consider more patient policy makers, the payoff of robust policies converge to the complete information benchmark. I finally explore how further restrictions on beliefs alter optimal policy and accelerate reputation building