Random Economic Disturbances and Lagged Countermeasures

Abstract

Fluctuations in domestic product and balance of payments are treated as Markov processes in discrete time instead of as deterministic paths. Emphasis is on the case when movements are in probability away from steady-state paths until they reach some barrier. The initiating disturbances are random events, and the task of policymakers is to respond with countervailing measures. These occur with time lags and produce stochastic processes of their own. The outcome is a probabilistic path which never quite matches the desired steady-state path. The first, one-dimensional case is that of the domestic product and the government budget. Next, the paper deals with the two-dimensional case of domestic product and balance of trade, with budget and exchange rate as instruments. Finally, it treats domestic product, trade balance, and capital account—using the budget, the exchange rate, and the monetary measures—as corrective devices.