Transaction Costs and Overinsurance in Government Transfer Policy

Benevolent governments lacking commitment ability provide too much insurance, if opportunistic private agents free ride on the government's concern and exert too little effort expecting government assistance. Yet, the costs of implementing the transfer policy work as a commitment device, alleviating the credibility problem. Indeed, despite of the lack of commitment capacity, the government might provide incomplete insurance because of these transaction costs. Therefore, transaction costs can increase welfare by resolving the dynamic inconsistency faced by a welfare maximizing policymaker.