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Macroeconomic Policy Design Using Large Rational Expectations Models: Methodology and Applications


  • Christodoulakis, Nikos
  • Gaines, Jessica
  • Levine, Paul L


This paper proposes and applies to the London Business School (LBS) model a general methodology for the design of macroeconomic policy using large rational expectations models. Design proceeds through the following four stages: first, a small, linear representation of the original large, nonlinear model is obtained. Second, control techniques adapted to ration al expectations models are applied. These result in optimal, open-loop trajectories for both the instruments and the endogenous variables, plus a feedback rule which stabilizes the economy about its open-loop path. The optimal policy is only optimal ex ante. Ex post it ceases to be optimal and there exists an incentive to renege. This is the problem of time inconsistency. In the absence of a reputation for precommitment the optimal policy will lack credibility and the policy-maker must be constrained to a sub-optimal policy from which there is no incentive to renege. The paper examines the possibility that a concern to maintain reputation may be sufficient to sustain the optimal, but time-inconsistent, policy.

Suggested Citation

  • Christodoulakis, Nikos & Gaines, Jessica & Levine, Paul L, 1988. "Macroeconomic Policy Design Using Large Rational Expectations Models: Methodology and Applications," CEPR Discussion Papers 274, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:274

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    References listed on IDEAS

    1. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-432, March.
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    9. Marini, Giancarlo & van der Ploeg, Frederick, 1988. "Monetary and Fiscal Policy in an Optimising Model with Capital Accumulation and Finite Lives," Economic Journal, Royal Economic Society, vol. 98(392), pages 772-786, September.
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    12. David Currie & Paul Levine, 1985. "Macroeconomic Policy Design in an Interdependent World," NBER Chapters,in: International Economic Policy Coordination, pages 228-273 National Bureau of Economic Research, Inc.
    13. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-680, May.
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