Applied Decision Analysis and Economic Behaviour

358 Pages·1984·12.381 MB·English

by  Peter J. Stemp, Stephen J. Turnovsky (auth.), A. J. Hughes Hallett (eds.)

Applied Decision Analysis and Economic Behaviour
ADVANCED STUDIES IN THEORETICAL AND APPLIED ECONOMETRICS
VOLUME 3
EDITORIAL BOARD
P. Balestra, Universite Oe Geneve, Switzerland
M.G. Dagenais, Universite de Montreal, Canada
A.J. Hughes Hallett, Erasmus University Rotterdam, The Netherlands
J.H.P. Paelinck, Netherlands Economic Institute, The Netherlands
R.S. Pindyck, Sioane School of Management, Massachusetts Institute of Technology,
Cambridge, United States
W. Welfe, University of Lodz, Poland
THE SPECIAL SCOPE OF THE SERIES
The fortress of econometrics has often been laid siege to from one or a few sides only.
According to their inspiration or inclination, authors have laid stress on model
specification, parameter estimation, testing and prediction or more generally the use
of models (prediction in particular being a rare bird in econometric literature). Special
topics, such as errors in the variables, missing observations, multi-dimensional data,
time-series analysis, dynamic specification, spatial autocorrelation, were dealt with as
and when the need arose.
No econometric exercises will ever be complete. Nevertheless, in setting up such
an exercise as part of an operational economic investigation, one may reasonably be
expected to try and encompass in it as many aspects of econometric modelling as may
present themselves. This se ries is devoted to the publication of work which, as far as
possible, addresses all aspects of a "complete econometric modelling" approach; for
instance, spatial econometrics or policy optimisation studies which account explicitly
for the specification, estimation or analysis of components of those models in the
widest sense, including any complementary components from the environment in
which the economic model must operate.
The very objective of the se ries may limit its extensions; but as Andre Gide put it
(Les faux monnayeurs), "iI est bon de suivre sa pente, pourvu que ce soit en montant".
All correspondence should be addressed to A.J. Hughes Hallet or to J.H.P. Paelinck
at the Erasmus University, PO Box 1738, 3000 DR Rotterdam, The Netherlands.
Applied Decision
Analysis and
Economic Behaviour
edited by
A.J. Hughes Hallett
1984 MARTINUS NIJHOFF PUBLISHERS, ....
11
a member of the KLUWER ACADEMIC PUBLISHERS GROUP'
DORDRECHT I BOSTON I LANCASTER •
Distributors
jor the United States and Canada: Kluwer Academic Publishers, 190 Old Derby
Street, Ringham, MA 02043, USA
jor the UK and Ireland: Kluwer Academic Publishers, MTP Press Limited,
Falcon Rouse, Queen Square, Lancaster LAllRN, England
jor all other countries: Kluwer Academic Publishers Group, Distribution Center,
P .0. Box 322, 3300 AR Dordrecht, The Netherlands
Library of Congress Cataloging in Publication Data
App1ied decision analysis and economic behavior.
(Advanced studies in theoretical and app1ied
econometrics ; 3)
1. Economic po1icy--Mathematical mode1s--Addresses,
essays, 1ectures. 2. Decision-making--Mathematical
models--Addresses, essays, lectures. 3. Uncertainty-
Mathematical mode1s--Addresses, essays, 1ectures.
4. Rational expectations (Economic. theory}--Addresses,
essays, 1ectures. I. Hal1ett, Andrew Hughes.
II. Series.
HD75.5.A65 1984 338.9'00724 84-6148
ISBN-13: 978-94-009-6163-0 e-ISBN-13: 978-94-009-6161-6
DOI: 10 .1 007/978-94-009-6161-6
Copyright
© 1984 by Martinus Nijhoff Publishers, Dordrecht.
Softcover reprint ofthe hardcover 1st edition 1984
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted in any form or by any means, mechanical,
photocopying, recording, or otherwise, without the prior written permission of
the publishers,
Martinus Nijhoff Publishers, P.O. Box 163, 3300 AD Dordrecht,
The Netherlands.
CONTENTS
INTRODUCTION
vi~
A.J. Hughes Hallett
PART I: EXPECTATIONS
Chapter 1. Optimal Stabilisation Policies under Perfect Foresight 3
P.J. Stemp and S.J. Turnovsky
Chapter 2. Towards the Resurrection of Macroeconomic Policies 23
L. Karp and A. Havenner
Chapter 3. Optimal Feedback and Feedforward Stabilisation of Exchange 33
Rates, Money, Prices and Output
S. Holly and R. Corker
PART 11: UNCERTAINTY
Chapter 4. Adaptive Econometric Forecasting Using an Approximate 63
Filtering-Smoothing Algorithm: the Case of the Israeli Meat Sector
A. Shmueli and C.S. Tapiero
Chapter 5. Controlling an Econometric Model Using Different Coefficient Sets 85
C -L. Sandbiom and H.A. Eiselt
Chapter 6. The Uncertainty Frontier as a Global Approach to the Efficient 97
Stabilisation of Economic Systems: Experiments with the
MICRO-DMS Model
M Deleau, C. Le Van. and P. Malgrange
PART In: POLICY ANALYSIS AND DECISION MODELS
Chapter 7. Incomes Policy in a Politi.cal Business Cyde Environment: 121
a Structural Model for the UK 1961-1980
M Desai, M. Keil, and S Wadhwani
Chapter 8. Multiperiod Prediction for Dynamic Models with Autocorrelated 145
Errors Conditiona! on Feedback Rules for Future Policy Variables
R. Friedmann
vi
Chapter 9. The Evaluation of Historical Poliey via Optimal Control 165
Teehniques
C Baum
PART IV: MARKET MANAGEMENT
Chapter 10. Endogenous vs. Exogenous Targets for Commodity Market 181
Stabilisation
B.L. Dixon and W. Chen
Chapter 11. Simple and Optimal Control Rules for Stabilising Speeulative 209
Commodity Markets
S. Ghosh, CL. Gi/bert, and A.1. Hughes Hallett
PART V: DECENTRALISATION AND MULTI-SECTOR PLANNING
Chapter 12. Behavioural Assumptions in Deeentralised Stabilisation Policies 251
1. W. Neese and R.S. Pindyck
Chapter 13. Stability Analysis of Large Seale Eeonomie Systems whieh have 271
a Multi-time Se ale
D.B. Petkovski
Chapter 14. The Loeation of a Firm on a Network 289
P. Hanjoul and J. -F. Thisse
EPILOGUE
Chapter 15. Style in Multisectoral Modelling 329
D.A. Kendrick
vii
INTRODUCTION
The optimisation of economic systems over time, and in an uncertain environment,
is central to the study of economic behaviour. The behaviour of rational decision
makers, whether they are market agents, firms, or governments and their agencies,
is governed by decisions designed to seeure the best outcomes subject to the perceived
information and economic responses (inlcuding those of other agents). Economic
behaviour has therefore to be analysed in terms of the outcomes of a multiperiod
stochastic optimisation process containing four main components: the economic
responses (the dynamic constraints, represented by an economic model); the objec
tive function (the goals and their priorities); the conditioning information (expected
exogenous events and the expected future state of the economy); and risk manage
ment (how uncertainties are accommodated).
The papers presented in this book all analyse some aspect of economic behaviour
related to the objectives, information, or risk components of the decision process.
While the construction of economic models obviously also has a vital role to play,
that component has received much greater (or almost exclusive) attention elsewhere.
These papers examine optimising behaviour in a wide range of economic problems,
both theoretical and applied. They reflect a variety of concerns: economic responses
under rational expectations; the Lucas critique and optimal fiscal or monetary poli
eies; market management; partly endogenous goals; evaluating government reactions;
locational decisions; uncertainty and information structures; and forecasting with
endogenous reactions.
The book has been partitioned accordingly into sections dealing with Expecta
tions, Uncertainty, Policy Models, Market Management, and Decentralisation. In the
first section Turnovsky and Stemp provide a theoretical examination of the macro
economic stabilisation problem under rational expectations and show that optimal
policy rules turn out to be time consistent if the adjustment costs are relatively large.
Karp and Havenner present a more general discussion of the determination of optimal
macroeconomic policies in the light of thc Lucas cri tique, and re ach similar conclusions.
Then HoHy and Corker undertake an empirical study of optimal monetary policies
under rational expectations, using a large scale econometric model of the V.K.
economy.
In the section on uncertainty, Shmueli and Tapiero consider how to make pre
dictions in a market containing several interdependent products and rational agents.
Sandbiom and Eiselt's paper returns to the macroeconomic arena and looks into the
viii
consequences of attempting to steer an economy with policies determined either
under parameter uncertainty or conflicting parameters from different models. These
are empirical exercises. The paper by Deleau, Le Van and Malgrange then introduces
the idea of efficient interventions in the face of significant uncertainties, arguing
that target variances should be traded off against one another along an 'uncertainty
fron tier' in the same way that their achievements are in a (deterministic) Pareto allo
cation of policy efforts.
The third sec ti on focusses on endogenising decisions as part of the modelling
process. Desai, Keil and Wadhwani model policy reactions when there is switching
between different regimes because governments change. Their study is set in the
classic situation of an incomes policy in a political cycle. An allied problem is the
generation of multiperiod predictions for an economy where policies are endogenised
through a feedback rule. Friedmann's contribution is to study a prediction mechanism
which accounts for the mutual interactions between predictions and policies. In a
more conventional contribution, Baum uses optimisation techniques as a yards tick
with which to judge historical policy performance.
The management of commodity markets is the subject of the fourth section.
Here Dixon and ehen examine the effects of different price support levels on the
stability of incomes in a rational agricultural market. In particular they contrast the
case where the support level is allowed to respond to market developments to the
case where that level is fixed in advance. Ghosh, Gilbert and Hughes Hallett investi
gate the scope and costs of price stabilisation in an international commodity market,
and then examine the information structure of successful intervention rules. Their
conclusion is that it is the contents of the information set (spccifically the anticipa
tions variables) rather than the type of decision rule which is important.
The final section deals with decentralised planning. The contribution of Neese
and Pindyck considers economic performance when decision making is decentralised
between fiscal and monetary authorities. Vsing an econometric model of the V.S.
economy, the effects of different private behaviour patterns (ranging from ignoring
or passively reacting to other agents, to actively persuing optimal equilibrium strate
gies) are compared empirically to cooperative decision making. Moving to the level
of industry planning, Petkovski examines the stability and control of a multi-sector
hierarchical system where decisions are taken with varying frequencies depending
on the level of the decision unit in the hierarchy. Finally, Hanjoul and Thisse remind
us that the optimisation of conflicting targets is just as necessary over space as it is
over time intervals. They review the optimallocation of firms within an industry,
when firms are now the decision makers.
ix
In practice much of this work is likely to involve large complex models with
extensive dynamics and many interacting sectors. In the epilogue, Kendrick puts for
ward some rules for presenting and encoding such models. These rules are part of
the recent attempts to design 'modelling languages' which will make complicated
models more accessible and intelligable to the general user.
The special feature common to these papers is that they try to internalise some
of the components of the decision process in order to make the modelling of econo
mic behaviour more -systematic. This is done at least as much to get information on
the decision structure as it is to select actual policies. Since one learns by doing,
these papers emphasise that there is a serious issue of experimental design in order
that the right questions should be asked. Experiments are vitally important since
they are the nearest we may come to testing alternative specifications ofthe compo
nents of the decision model because (a) there is no possibility of manipulating an
economic system under repeatedly identical experimental conditions (indeed there
is no possibility of 'live' experiments), (b) there is an inherent randomness in human
behaviour not found in physical systems, (c) there are observation and measurement
problems which can never be fully overcome.
Obviously there is no reason to expect nature (or indeed governments) to per
form the crucial controlled experiments which will enable us to distinguish between
alternative specifications ofthese components. In that case 'laboratory' experiments,
not 'live' ones, must be conducted. The whole decision model should be subject to
severe testing during its construction and the derivation of policy recommendations,
with the aim of correcting specifications which would later appear to have led to
mistaken policy proposals. The case against explicit optimisation in empirie al work
usually focusses on the difficulty of formulating and accomodating the risks, the
priorities, and the information system adequately. Yet if, as is now generally accepted,
it is necessary to use an explicit model (and probably an econometric one, whether
simple or sophisticated) to ensure the accountability and mutual consistency of pro
jections, then by the same token adecision model explicit in all four components is
crucial for exact1y the same reasons.
Warwiek, February 1984 A.J. Hughes Hallett
PART I
EXPECTATIONS