THE APPLICABILITY OF THE TRADITIONAL THEORY OF ECONOMIC POLICY

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 policy maker'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 policy makers might be satisficing is discussed. The role played by political factors is considered in the light of the public choice literature.     

Econom(etr)ics of crime and litigation

Economists approach the behaviour of potential criminals, litigants and law enforcement agencies in terms of rational choice: the actors choose the best alternatives in terms of costs and benefits within the choices open to them. The prime focus of economists is on the general factors in society affecting the crime and litigation level and on the interaction between the crime and litigation level and the legal system. In doing so they have to study the interaction between the micro level of individual decision making and the macro level of the law enforcement system reacting on these decisions. Data are often only available at aggregate (macro) level. Econometric studies at the macro level, especially time series, have the problem that many effects have to be estimated from a limited number of data. Various types of studies and some empirical results regarding crime, litigation and the workload of judicial services are discussed.     

Finance,income inequality and income redistribution

Using a panel fixed effects model for a large sample of countries covering 1975–2005, we test the hypothesis that income inequality caused by finance (financial development, financial liberalization and banking crises) is related to more income redistribution than inequality caused by other factors. Our results provide evidence in support of this hypothesis. We also find that the impact of inequality on redistribution is conditioned by ethno-linguistic fractionalization. Our findings are robust to the inclusion of several control variables suggested by previous studies.