Optimal Stabilisation Policies Under Perfect Foresight
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The problem of choosing between inflation and unemployment rates continues to be a fundamental one in most modern economies. The question of the optimal choice of trade-off between them has been investigated by a number of authors. The earliest studies, conducted in the mid 1960’s were purely static; see, for example, Lipsey (1965) and Brechling (1968). Subsequently, the analysis was extended to a dynamic context on the assumption that inflationary expectations, known to be a critical aspect of the trade-off, follow some gradual evolutionary process such as an adaptive scheme; see, for example, Phelps (1967, 1972) and Turnovsky (1981). These authors derive an optimal path in which the inflation rate adjusts gradually towards some steady-state equilibrium, while the unemployment rate converges slowly towards its natural rate. The transitional dynamic adjustment path depends upon the parameters characterising the economy and the preferences of the policy maker, including in particular, the rate of time discount.
KeywordsUnemployment Rate Optimal Policy Price Level Optimal Path Natural Rate
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