The balance of payments and optimal economic policy: The assignment problem revisited

Abstract

In this paper a policy model suggested by Niehans is extended to show the particular and non-optimal character of the so-called assignment rules in the theory of economic policy in open economies. From the assumption that the government has two arguments in its objective function — income and the exchange reserves — an optimal policy model is developed with the techniques of optimal control theory. The optimal control rules derived from this model are easily compared with the traditional assignment rules. The model also shows how rational behaviour of the policymakers could lead to the creation of a political business cycle.