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Title: Essays on optimal government policy
Author: Papi, Laura
ISNI:       0000 0001 3467 1302
Awarding Body: University of Warwick
Current Institution: University of Warwick
Date of Award: 1993
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The aim of the thesis is to advance our understanding of the behaviour of, and interactions between, policymakers and the public. The government’s actions result from its objectives and the constraints it faces, hence policy decisions are endogenous. Similarly, private operators are considered to be rational and forward-looking. Thus, the strategic interaction between the policy authorities and the public constitutes the core of the thesis. What emerges from the analysis is how the government chooses the optimal policy and how the public forms its expectations. Although the entire thesis deals with optimal policy decisions, Part I studies the government/public interaction in the context of exchange rate management, and focuses on the comparison between the time-consistent and time-inconsistent strategies, while Parts II and III explore the policymakers’ and private sector’s behaviour in an environment with uncertainty and incomplete information. In such a realistic and complex framework. Part II attempts to explain actual and expected inflation in a closed economy, while Part III attempts to do this in an open economy after a change in the exchange rate regime. Part I analyses optimal exchange rate management. In particular, it examines the government’s optimal policy when a country aims at stabilizing the exchange rate, but wants to retain some degree of monetary independence. The attention is focused on the time-consistency issues that arise in this framework and the purpose of Chapter 1 is to build a bridge between the time-consistency literature and optimal exchange rate management studies, which seem to have neglected this important issue. Chapter 1 stems from the observation that countries participating in quasi-fixed exchange rate arrangements want to retain some monetary independence and sometimes have conflicting objectives. Therefore, the questions to be addressed here are: what is the optimal government policy? And how does the optimal time-inconsistent strategy compare with the incentive-compatible one? The analysis is carried out using a deterministic continuous-time model. Part II builds on the well known Barro-Gordon monetary policy model in order to examine how the presence of uncertainty and asymmetric information impinges on the policy formation process. Uncertainty is a crucial element of reality and it is introduced in the form of the government’s imperfect command of inflation. The introduction of information asymmetry renders the study of the strategic interactions between the policymakers and the public more interesting and complex, because the scope for manipulating the less-informed player’s expectations is enhanced. Asymmetric information enters the model as lack of information on the part of the private sector about the government’s preferences. The private sector’s behaviour is not assumed to be gullible and naive, and their learning process reflects this. The government’s optimal policy is also the optimal signalling strategy, since the policymakers take into account the information content of their actions. The analysis is carried out using a continuous-time stochastic model and the techniques used involve the Bellman principle of optimality and the Kalman-Bucy filter. Part III, which comprises Chapters 3 and 4, is concerned with an open economy model in which asymmetric information is present. Chapter 3 analyses the government's optimal policy, with respect to the choice of planned inflation, when a country changes exchange rate regime. The regime switch examined is that from free floating, where purchasing power parity always holds, to a pegged regime. This is a situation in which information asymmetries are particularly relevant, since the public has never before been able to observe the policymakers’ preferences about competitiveness. After the regime shift, the government can affect the real exchange rate, and hence the public can gather information about the government’s preferences from its actions. Such a change in the exchange rate regime is often advocated as a way of implementing a disinflation. However, some have argued that, in the presence of information asymmetries, and hence when the public has to learn about the characteristics of the new environment, the effectiveness of this anti-inflationary device could he impaired. This chapter challenges this view and aims at analysing the optimal policy and the public’s evolution of inflationary expectations in such a scenario, taking fully into account the strategic interactions between the two players. The model used is stochastic and the techniques employed are the same as in Part II. Chapter 4 explores the role of the information structure using the model developed in Chapter 3. Its purpose is to examine whether simple changes in the information structure can alter the solution to the government’s optimization and, if so, to highlight the differences.
Supervisor: Not available Sponsor: Istituto Luigi Einaudi ; Banco di Sicilia
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available
Keywords: HD Industries. Land use. Labor ; HG Finance