A Multivariable System Approach for the Assessment of the Influence of Fiscal Policy to Business Cycle Shocks

The authors consider a multivariable system comprising a set of macroeconomic variables as inputs, states and outputs. In this setting the authors assess the control potential of fiscal policy versus a large negative business cycle shock that affects the output of the system. The inputs considered for this matter are the cyclical components of government spending and taxes. The states are the cyclical components of consumption and investment. These variables convey information to the policy maker at each time period. The output of the system is the cyclical component of GDP. In order to assess the control potential of government fiscal policy we begin by solving an optimal control problem minimizing the deviations of log GDP from its trend subject to a multivariable system and a set of input - output inequality constraints. Based on the results obtained the authors propose a set of optimal control indicators used to evaluate the effectiveness of fiscal policy action against a large negative business cycle shock and the potential controllability of the system.