The Applicability of the Traditional Theory of Economic Policy

Ben C J van Velthoven

Journal of Economic Surveys, 1990, vol. 4, issue 1, 59-88

Abstract: The traditional theory of economic policy requires targets, instruments, an empirical economic model, and a social welfare or criterion function to be specified in order to derive the optimal economic policy. Empirical studies of reaction functions suggest that economic policy is carried out in some systematic manner, subject to interference from political factors. This survey addresses the problems of specifying, estimating and applying an economic model when economic policy is following a path specified by a reaction function. Attention is paid to rational expectations, the Lucas' critique, and the policy neutrality proposition. Lack of knowledge of the policymaker's objective function poses the most serious difficulty when applying the theory of economic policy. Various methods of determining this function are reviewed, and the possibility that policymakers might be satisficing is discussed. The role played by political factors is considered in the light of the public choice literature. Copyright 1990 by Blackwell Publishers Ltd

Date: 1990
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