Economy Policy Models

Abstract

The comparative static models and the dynamic models which we have so far discussed hypothesise relationships between economic variables. These relationships are embodied in the specification of the structural equations which, in turn, are determined by economic considerations of both a theoretical and institutional nature. With these models, we have analysed the characteristics of equilibrium conditions and answered certain questions concerning comparative statics and stability conditions. However, model making should be more than an intellectual exercise and, indeed, we want to use models to help us to see how we might control economic events. Science is not only concerned with explanation and prediction but also with control over our environment. To speak of control over our environment implies that we have objectives that are deemed desirable and it is at this juncture that positive and normative economics merge into economic policy planning. In particular, the governments of countries are often concerned to use economic policy to achieve social and political ends. In principle, rational planning presupposes that, in some way, we know how key economic variables can be influenced in order to achieve certain objectives. For example, macroeconomic models predict what will happen to aggregate income when certain variables are manipulated in particular ways. Often the pursuit of a particular objective will set up side effects that mitigate against the achievement of the original objective. Until recently, for example, it was believed that there is a trade-off between full employment and inflation. The question of which objectives should have priority is a normative issue, usually decided by the government of the day. The fact is that the state intervenes in the operation of the market, both as a buyer and seller and as an agent of control. Governments build roads, schools and hospitals and also intervene in money and capital markets in order to control and manipulate key variables such as the rate of interest and the liquidity position of businesses.