Optimal economic stabilization policies under decentralized control and conflicting objectives

This paper derives methods for the calculation of optimal stabilization policies under the assumption that monetary and fiscal control are exercised by separate authorities who may have different objectives. Each authority minimizes its own quadratic cost functional subject to the constraint of a linear econometric model. Nash solution strategies are calculated for this discrete-time differential game, both in the context of open-loop and closed-loop behavior (in the closed-loop framework each authority can continually revise his policy in response to the evolving strategy of the other authority). The results are applied to a small econometric model, and show how the degree of fiscal or monetary control depends on the particular conflict situation, and how conflicting policies are "sub-optimal" in comparison with coordinated policies.