The purpose of this paper is to analyze short-term economic stabilization policy in the past Korean economy applying the optimal control theory.
A quarterly econometric model of Korea was built and validated using the historical data.
Aggregate demand management policies with monetary and fiscal instruments are controlled to achieve two, often conflicting, economic objectives, economic growth and price stability.
Main results from the optimal control of the Korean econometric model during the Second and Third Five-Year Economic Planning periods are as follows;
First, aggregate demand management policy shows considerably larger effectiveness during the Second Five-Year Economic Planning period than during the Third one, due to less outside shocks especially in price sector.
Second, since larger outside shocks in price sector make aggregate demand management policy per se inefficient, combining with other policies such as income policy and exchange policy is required.
Third, it is shown that distinct effective tradeoff relation exists between economic growth rate and inflation rate, and that its substitution rate remains relatively stable. It implies that because there are conflicts between the two objectives, careful judgement on relative losses is needed.
