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Stabilizing an unstable economy: On the choice of proper policy measures

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  • Asada, Toichiro
  • Chiarella, Carl
  • Flaschel, Peter
  • Mouakil, Tarik
  • Proaño, Christian R.

Abstract

In the last months, the world's economies were confronted with the largest economic recession since the Great Depression. The occurrence of a worldwide financial market meltdown as a consequence originally stemming from of the crisis in the US subprime housing sector was only prevented by extraordinary monetary and fiscal policy measures implemented at the international level. Although the world economy seems now to be slowing recovering, it is worthwhile exploring the fragility and potentially destabilizing feedbacks of advanced macroeconomies in the context of Keynesian macro models. Fragilities and destabilizing feedback mechanisms are known to be potential features of all markets-the product markets, the labor market, and the financial markets. In this paper we focus in particular on the financial market. We use a Tobin-like macroeconomic portfolio approach, and the interaction of heterogeneous agents on the financial market to characterize the potential instability of the financial markets. Though the study of the latter has been undertaken in many partial models, we focus here on the interconnectedness of all three markets. Furthermore, we also study how labor market, fiscal and monetary policies can stabilize unstable macroeconomies. Besides other stabilizing policies we in particular propose a countercyclical monetary policy that sells assets in the boom and purchases assets in recessions. Modern stability analysis is brought to bear to demonstrate the stabilizing effects of those suggested policies. --

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Bibliographic Info

Article provided by Kiel Institute for the World Economy in its journal Economics: The Open-Access, Open-Assessment E-Journal.

Volume (Year): 4 (2010)
Issue (Month): 21 ()
Pages: 1-43

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Handle: RePEc:zbw:ifweej:201021

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Keywords: Monetary business cycles; portfolio choice; (in-)stability; stabilizing policy measures;

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References

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  1. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, Econometric Society, vol. 71(1), pages 173-204, January.
  2. Semmler, Willi & Bernard, Lucas, 2012. "Boom–bust cycles: Leveraging, complex securities, and asset prices," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 81(2), pages 442-465.
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Cited by:
  1. Westerhoff, Frank, 2011. "Interactions between the real economy and the stock market," BERG Working Paper Series 84, Bamberg University, Bamberg Economic Research Group.
  2. Charpe, Matthieu & Flaschel, Peter & Hartmann, Florian & Proaño, Christian, 2011. "Stabilizing an unstable economy: Fiscal and monetary policy, stocks, and the term structure of interest rates," Economic Modelling, Elsevier, Elsevier, vol. 28(5), pages 2129-2136, September.
  3. Chiarella Carl & Flaschel Peter & Köper Carsten & Proaño Christian & Semmler Willi, 2012. "Macroeconomic Stabilization Policies in Intrinsically Unstable Macroeconomies," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, De Gruyter, vol. 16(2), pages 1-38, April.
  4. Toichiro Asada & Carl Chiarella & Peter Flaschel & Tarik Mouakil & Christian Proaño & Willi Semmler, 2011. "Stock‐Flow Interactions, Disequilibrium Macroeconomics And The Role Of Economic Policy," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 25(3), pages 569-599, 07.
  5. Soon Ryoo & Peter Skott, 2011. "Public debt and full employment in a stock-flow consistent model of a corporate economy," UMASS Amherst Economics Working Papers, University of Massachusetts Amherst, Department of Economics 2011-26, University of Massachusetts Amherst, Department of Economics.
  6. Chiarella Carl & Di Guilmi Corrado, 2012. "The Fiscal Cost of Financial Instability," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, De Gruyter, vol. 16(4), pages 1-29, October.
  7. Eleonora Cavallaro & Bernardo Maggi, 2014. "State of confidence, overborrowing and the macroeconomic stabilization puzzle," DSS Empirical Economics and Econometrics Working Papers Series, Centre for Empirical Economics and Econometrics, Department of Statistics, "Sapienza" University of Rome 2014/2, Centre for Empirical Economics and Econometrics, Department of Statistics, "Sapienza" University of Rome.

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