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Output and Interest Rates. Jump Variable and Phase Diagram Switching Methodologies

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Author Info

  • Peter Flaschel

    (University of Bielefeld)

  • Carl Chiarella
  • Reiner Franke
  • Willi Semmler

Abstract

In this paper we reconsider a model of Blanchard and Fischer which reformulated Keynesian IS-LM analysis from the perspective of a richer array of financial assets, namely short-term and long-term bonds, and thus from the perspective of the term structure of interest rates. The basic change in this extension of the IS-LM approach is that investment demand (and also consumption demand) now depend on the long-term rate of interest in the place of the short-term rate. This implies that the IS-curve and the LM-curve are no longer situated in the same diagram, but have to be linked via the dynamics of long-term bond prices (in the approach of Blanchard and Fischer based on perfect substitutes, perfect foresight and the jump variable technique), thereby creating one of the links for the real-financial interaction to be investigated, the dynamic multiplier process and the conventional LM curve representing the other one. Based on this dynamic interaction of real and financial markets we will reflect the outcomes achieved by Blanchard and Fischer from the perspective of imperfect substitutes and imperfect forecasts of capital gains in the place of the limit case of perfect substitutes and myopic perfect foresight. We derive on this basis an alternative to the conventional jump variable technique and its treatment of unanticipated and anticipated monetary and fiscal policy, which is global in nature and does not depend on the local analysis of saddlepath stability as in the case of the jump variable technique. Endogenous fluctuations around the unique steady state of the model arise from patching two nonlinear dynamical systems, each of which -- but not their interaction -- is of a very simple nature.

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Bibliographic Info

Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Workshop Papers, January 2001 with number 1B.1.

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Date of creation: 04 Jan 2001
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Handle: RePEc:ams:cdws01:1b.1

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Cited by:
  1. Carl Chiarella & Peter Flaschel & Reiner Franke & Willi Semmler, 2000. "Output, Financial Markets and Growth," Working Paper Series 108, Finance Discipline Group, UTS Business School, University of Technology, Sydney.

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