RETALIATING AGAINST TERRORISM - RATIONAL-EXPECTATIONS AND THE OPTIMALITY OF RULES VERSUS DISCRETION

The application of rational expectations theory to policies of retaliation against terrorism suggests that only unexpected retaliations will be effective in causing terrorist attacks to deviate from their natural rate and that there is a time inconsistency problem in responding to terrorism. Since the optimal response rate to terrorism would never be believable to the terrorists, the first best policy may be for the government retaliating against terrorism to have its response rate constrained by an externally imposed rule. A time series intervention model of terrorist attacks against Israel supports the natural rate hypothesis and, therefore, also the desirability of a retaliatory rule over policy discretion. Israeli retaliation for the 1972 Munich massacre was the first Israeli retaliation of unexpectedly large magnitude, and it produced a temporary deviation of terrorist attacks from the natural rate. Retaliation has no long-term deterrent or escalation effect.