STABILIZATION POLICY AS BIFURCATION SELECTION: WOULD STABILIZATION POLICY WORK IF THE ECONOMY REALLY WERE UNSTABLE?

Abstract

Taken literally, the concept of “stabilization policy” implicitly assumes that the macroeconomy is unstable without imposition of a policy. Hence, selection of a “stabilization policy” can be viewed as selection of a policy to bifurcate the system from an unstable to a stable operating regime. The literature on dynamics of high-dimensional systems suggests that successful bifurcation selection is challenging. As an experiment to investigate this point of view, we use the continuous-time UK dynamic macroeconometric model. Under assumptions designed to be most favorable to stabilization policy, we find that policies that would produce successful bifurcation are very complicated. We also find that less complicated policies based upon reasonable economic intuition can be counterproductive, since such policies can contract the size of the stable subset of the parameter space. In fact, an economy that is dynamically stable without policy, but subject to stochastic shocks, could be bifurcated to instability with imposition of a poorly designed “stabilization” policy.