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

The application of rational expectations theory to policies of retalia tion against terrorism suggests that only unexpected retaliations will be effective in causing terrorist attacks to deviate from their natur al rate and that there is a time inconsistency problem in responding t o 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 con strained by an externally imposed rule. A time series intervention mod el of terrorist attacks against Israel supports the natural rate hypot hesis and, therefore, also the desirability of a retaliatory rule over policy discretion. Israeli retaliation for the 1972 Munich massacre w as the first Israeli retaliation of unexpectedly large magnitude, and it produced a temporary deviation of terrorist attacks from the natura l rate. Retaliation has no long-term deterrent or escalation effect.