Optimal Fiscal Strategy for Economic Stabilization: An Econometric Study with Illustrative Application to Canada

Abstract

The primary objective of this thesis is to develop a methodology for applying econometric models to problems of economic policy, and to illustrate it in terms of fiscal policy by applying it to problems of economic stabilization in Canada during the period 1967-69. It was assumed that the fiscal policy-maker in Canada has a preference (loss) function which is a weighted sum of squared deviations between the actual and the desired values of two target variables (changes in the GNE price deflator and the number of persons unemployed) and three instruments (changes in government expenditure on goods and services, and the personal and corporation income tax rates). Then, an intermediate sized annual econometric model of the Canadian economy was developed, subject to which the preference function was minimized. Since the parameters of the preference function were not given, thirty-six experiments of optimization were made under a range of plausible values of the relevant parameters. It was found that the numerical values of the target variables indicated by the optimal strategy were closer to the desired values and more stable in their movements than actual values. Also the results of various experiments suggested that the optimal strategy was relatively insensitive to changes in parameter values over a rather wide range.