A Study of the Alternative Policies in the Control of a National Economy via Dynamic Programming

Abstract

practice to varying extents in the North American economy. In the United States, President Johnson's surtax in 1968 to inhibit the economy's inflationary surge is an example of fiscal policy; the formulation of the guidepost policy in the Council of Economic Adviser's Report in 1962 is a recognition of the importance of wage control; and in recent years, the monetary rules promulgated by Professor Friedman have been influential. In Canada, measures of fiscal and monetary control have also been undertaken; and the recent Price and Income Commission under the lead of Dr. John Young is an attempt to induce labour and business to adopt a voluntary wage restraint. However, all these attempts, both in the United States and in Canada, have not been altogether successful. In fact, recent data indicate strongly the simultaneous existence of inflation and unemployment in the North American economy. Amongst the increasing number of economists who share the opinion that existing methodologies have to be re-examined, Weintraub [10] has proposed an income policy based on a tax on excessive wage settlements. This paper attempts to cast a light on some of the long-standing issues regarding the effectiveness and relative merits of alternative policies by simulation studies using an illustrative economic model. No econometric technique has been used to estimate model parameters. It is believed, however, that an empirical model may not be appropriate for studying the potential impact of certain policy variables since we have no guarantee that the econometrically estimated parameters will yield valid dynamic, closed-loop simulations. What is needed therefore is a new estimation technique that uses as its criterion of goodness-of-fit, How well does the model simulate and predict ? rather than How well does it fit historical data ? Using an illustrative model, optimal policies are formulated via dynamic programming. The application of the latter to a non-linear