We develop a framework to study the
effects of policies of uncertain duration on consumption dynamics under
both complete and incomplete markets. We focus on the dynamic implications
of market incompleteness, specifically on the lack of state-contingent
bonds. Two policies are considered: pure output-increasing and
tariff-reducing (trade liberalization). With complete markets, the
output-increasing
policy leads to flat consumption, whereas with no
contingent assets, consumption jumps upward on the announcement of the
policy, continues rising as long as the policy is in effect, and collapses
when it is abandoned. A similar consumption path obtains in a trade
liberalization in the realistic case of low elasticity of substitution and
no rebate of tariffs. Market incompleteness rationalizes the existence of
gradual changes in consumption.