Optimal Control for Econometric Models: An Approach to Economic Policy Formulation

310 Pages·1979·21.328 MB·English

by  Dr Sean Holly, Mr Berç Rüstem, Dr Martin B. Zarrop (eds.)

OPTIMAL CONTROL FOR ECONOMETRIC MODELS
OPTIMAL CONTROL
FOR ECONOMETRIC
MODELS
An Approach to Economic Policy
Formulation
edited by
Sean Holly, Ber~ Riistem and Martin B. Zarrop
Selection and editorial matter © Sean Holly, Ber~ Riistem and
Martin B. Zarrop 1979;
Chapter I © J. H. Westcott, M. B. Zarrop, S. Holly, B. Riistem and R.
Becker 1979; Chapter 2 © Gregory C. Chow 1979; Chapter 3 © John F.
Helliwell 1979; Chapter 4 © D. A. Livesey 1979; Chapter 5 © Mark
Salmon and Peter Young 1979; Chapter 6 © B. Riistem, J. H. Westcott,
M. B. Zarrop. S. Holly and R. Becker 1979; Chapter 7 © A. Hughes-
Hallett 1979; Chapter 8 © S. Holly, B. Riistcm, J. H. Westcott, M. B.
Zarrop and R. Becker 1979; Chapter 9 © David Kendrick 1979; Chapter
10 © M. B. Zarrop, S. Holly, B. Riistem, J. H. Westcott and· M.
O'Connell 1979; Chapter 11 © Lawrence R. Klein 1979; Chapter 12
© T. S. Barker 1979
Softcover reprint of the hardcover 1st edition 1979
All rights reserved. No part of this publication may be
reproduced or transmitted, in any form or by any means,
without permission
First published 1979 by
THE MACMILLAN PRESS L TO
London and Basingstoke
Associated companies in Delhi
Dublin Hong Kong Johannesburg Lagos
Melboume New York Singapore Tokyo
Transferred to digital printing 1999
02/790
Recent Developments in National Economic Policy
Formulation (Conference), London, 1977
Optimal control for econometric models
l. Economics- Mathematical models- Congresses
2. Econometrics-Methodology-Congresses
3. Control theory-Congresses
I. Title II. Holly, Sean III. Riistem, Ber~
IV. Zarrop, Martin B. V. Imperial College of Science
and Technology. Department of computing and control
330'.01'82 HBI41
ISBN 978-1-349-16094-5 ISBN 978-1-349-16092-1 (eBook)
DOI 10.1007/978-1-349-16092-1
This book is sold subject
to the standard conditions
of the Net Book Agreement
Contents
Foreword by J. H. Westcott VII
Pref ixe IX
List of Contributors X
Introduction xi
PART I
A Control Theory Framework for Policy Analysis J. H.
Westcott, M. B. Zarrop, S. Holly, B. Riistem and R. Becker 3
PART II ASPECTS OF THEORY AND POLICY
2 Effective Use of Econometric Models in Macroeconomic
Policy Formulation Gregory C. Chow 31
3 Recent Developments in Policy Optimisation for an Open
Monetary Economy John F. Helliwell 40
4 The Role of Feedback in Economic Policy D. A. Livesey 58
5 Control Methods and Quantitative Economic Policy
Mark Salmon and Peter Young 74
6 Iterative Respecification of the Quadratic Objective Func-
tion B. Riistem, J. H. Westcott, M. B. ZmTop, S. Holly and
R. Becker 106
7 The Sensitivity of Optimal Policies to Parametric and
Stochastic Changes A. Hughes-Hallett 134
PART III STABILISATION POLICIES WITH SMALL
LINEAR ECONOMETRIC MODELS
8 Control Exercises with a Small Linear Model of the UK
Economy S. Holly, B. Riistem,J. H. Westcott, M. B. Zarrop
and R. Becker 167
9 Adaptive Control of Macroeconomic Models with
Measurement Error David Kendrick 204
v
Contents
VI
PART IV STABILISATION POLICIES WITH LARGE
NONLINEAR ECONOMETRIC MODELS
10 Control of the LBS Econometric Model via a Control
Model M. B. Zarrop, S. Holly, B. Riistem, J. H. Westcott
and M. O'Connell 231
11 Managing the Modern Economy: Econometric Specifi-
cation Lawrence R. Klein 265
12 Economic Policy Formulation in a Large-scale Model
T. S. Barker 286
Index 300
Foreword
In view of the interest that has recently been shown in national policy
formulation it was thought useful in the spring of 1977 to hold a
conference on 'Recent Developments in National Economic Policy
Formulation'. The idea was to provide a forum to practising economists
in academic and Government circles at which ideas and recent develop-
ments in economic policy formulation through the use of macroecon-
omic models could be presented and discussed.
In the event just over 100 invited participants took part in the
conference, which was held at Imperial College on 19-21 April 1977
under the auspices of the Department of Computing and Control.
Financial assistance from the Social Science Research Council enabled a
number of distinguished contributors from overseas to attend and
present papers at the conference and to enliven and broaden the basis of
the discussion. The choice of date, being about a month after the UK
Budget announcement, had the happy outcome of attracting a pleasingly
high attendance of UK Treasury officials, to the benefit of the free-
ranging discussions that occurred.
It is now felt that the analytical techniques and technical material that
were presented at the conference deserves closer study by a wider
audience; and hence this volume, whose chapters are based on papers
presented then.
I would like to record our thanks to members of the Steering
Committee for the conference for their good advice that enabled us to get
together such a lively and informed conference, to the authors for their
interesting and learned papers and to the editors of this volume who have
tried to distil the quintessence of the proceedings in the twelve chapters
of this book.
J. H. WESTCOTT
Programme of Research in Econometric Methods
Department of Computing and Control
Imperial College
vii
Preface
This volume is based on a conference on 'Recent Developments in
Economic Policy Formulation' held in April1977 by the SSRC-financed
Programme of Research into Econometric Methods in the Department
of Computing and Control, Imperial College London.
A few of the papers have been altered for presentation in this volume.
Terry Barker (Chapter 12) substantially revised his paper while Mark
Salmon and Peter Young (Chapter 6) prepared their contribution
specially for this volume. The paper by Westcott, Zarrop, Holly, Riistem
and Becker (Chapter 1) has been largely rewritten so as to provide a
general introductory essay on optimal control in economic policy-
making.
The Programme of Research into Econometric Methods was orig-
inally set up under the joint direction of Dr J. Bray, Professor M. Peston
and Professor J. H. Westcott in 1971. A debt of gratitude is owed to P. E.
Caines, K. D. Wall and A. J. Preston, who carried out much of the early
theoretical work, as well as to Phillipa Carling, Sally Donovan, M.
Kharusi, J. Peddicord, M. Salmon and K. Vellupillai, without whose
efforts the present work of the Programme would have been impossible.
We wish to thank Helen Rogers for her patience and typing skill
during the preparation for the conference and in preparing a final
typescript for publication.
SEAN HOLLY
BER<;: ROSTEM
MARTIN B. ZARROP
ix
List of Contributors
Dr T. S. Barker Cambridge University
Mr R. G. Becker Imperial College London
Professor G. C. Chow Princeton University
Professor J. F. Helliwell University of British Columbia
DrS. Holly Imperial College London
Dr A. Hughes-Hallett Erasmus University, Rotterdam
Professor D. Kendrick University of Texas
Professor L. R. Klein University of Pennsylvania
Dr D. A. Livesey Cambridge University
Dr M. J. O'Connell Science Research Council (Rutherford
Laboratory)
Mr B. Riistem London School of Economics
Mr M. Salmon Australian National University, Canberra
Professor J. H. Westcott Imperial College London
Professor P. Young Australian National University, Canberra
Dr M. B. Zarrop Imperial College London
X
Introduction
The history of attempts to introduce control theoretic concepts into the
field of economics goes back at least twenty years. It has only been in the
last decade, however, that the explosion in computer technology coupled
with increasing sophistication in econometric modelling have opened the
way to rapid progress in the formulation and solving of optimal
stabilisation problems. Control theory has also been of use in the
theoretical investigation of dynamic economic systems. The papers in
this volume belong primarily to the first and more applied strand in the
literature and are addressed mainly to aspects of the application of
control methods to macroeconomic policy-making.
The contents have been divided into four parts so as to bring loosely
related papers under common headings. The first and introductory
paper by Westcott et a/. is designed to convey the salient features of
optimal economic policy-making. It is far from being an exhaustive
account since to do justice to the entire field would require a book in
itself. The paper covers many of the important concepts that arise
repeatedly in subsequent chapters and places optimal policy-making and
current practices in the broader context of constrained optimisation.
Part II contains a number of differing papers. Chow describes a
twelve-step procedure for applying stochastic optimal control tech-
niques to econometric models. A means of judging between the possibly
contradictory recommendations of more than one model is proposed in
terms of a payoff matrix. Minimising the expected loss associated with
alternative policies can then be achieved by minimax strategies or by
assigning probabilities to the different models and adopting a Bayesian
decision procedure. The contribution by Helliwell is concerned with
drawing out the implications for optimal policy-making of recently
developed theories of open economies under fixed and flexible exchange
rates. The papers by Livesey and by Salmon and Young are similar in
approach in so far as they seek to derive their inspiration, not from
'modern' optimal control theory, which relies very heavily upon state
space representations, but from recent developments and improvements
in 'classical' theory. Particular emphasis is placed upon the concepts of
XI