Toward The Resurrection of Optimal Macroeconomic Policies
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The recognition of rational expectations has lead some to conclude that control theory is not an appropriate technique for determining policy. This conclusion is incorrect. The presence of rational expectations on the part of the public merely requires that policy makers solve a more sophisticated control problem, as we demonstrate below. Section 2 reviews the problem of the ‘inconsistency’ of optimal policies in a world of rational expectations. The problem forms the basis for the rational expectations criticism of control theory. Section 3 casts the policy making process as a dynamic Stackelberg game. After examining the mathematics of the anomaly, which hinges on the inapplicability of the Principle of Optimality, several types of control solutions which do not exhibit the anomaly are discussed. Section 4 summarises the results.
KeywordsOptimal Policy Open Loop Rational Expectation Control Rule Feedback Rule
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- Papavassilopoulos, G.P. and J.B. Cruz, Jr. (1980), ‘Sufficient conditions for Stackelberg and Nash strategies with memory’, Journal of Optimisation Theory and Applications, 31, pp. 253–260.Google Scholar