Authors: ILIAS KOSTARAKOS

Title: Fiscal Policy, Linear Feedback Control and Debt Stabilization

Abstract

The purpose of this paper is to provide an alternative framework for the design of (short-term) fiscal policy that is based on the algorithmic linear feedback control methodology.In the context of a linear, deterministic model of the macroeconomy, we set certain (fixed) targets for the levels of GDP and public debt (the state variables) and we aim at designing policy rules, i.e. feedback laws for the policy instruments (control variables) available to the policymaker (in our case, government expenditures and taxation) so that the desired target-levels are exactly met. That is, we intend to achieve complete tracking of the state variables. For this purpose, we employ a technique from mathematical control theory that is known as model matching or model following.The solution is based on the calculation of feedback policy rules, i.e. functions that relate the policy instruments to lagged values of GDP and public debt, as well as lagged values of the instruments. These policy rules provide the exact time-path of the policy instruments necessary for attaining the target-levels.Finally, in order to examine the efficacy of our approach, we run a series of simulations for a stylized economic system and try to draw some policy conclusions.