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Solving Stochastic Saddlepoint Systems: A Qualitative Treatment With Economic Applications

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Author Info

  • MILLER, M.
  • WELLER, P.

Abstract

We examine the effect of introducing stochastic shocks into a linear rational expectations model with saddlepoint dynamics generated by a forward looking asset price. We derive the fundamental differential equation governing the path of the asset price as a function of the 'sluggish' variable. The equation does not admit of closed form solutions in general, but we provide a complete qualitative characterization of the solution paths which are symmetric about equilibrium. The first application analyzes how financial markets might react to the implementation of fiscal stabilization policy where public expenditures are only adjusted when GNP moves outside a threshold around a target level. The second application examines exchange rate behavior in the presence of a currency subject to a known realignment rule requiring an adjustment to monetary polic.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 309.

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Length: 25 pages
Date of creation: 1988
Date of revision:
Handle: RePEc:wrk:warwec:309

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Keywords: economic theory ; stochastic processes ; monetary policy;

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Cited by:
  1. Barry Eichengreen & Peter Garber, 1990. "Before the Accord: U.S. Monetary-Financial Policy 1945-51," NBER Working Papers 3380, National Bureau of Economic Research, Inc.
  2. Buiter, Willem H & Pesenti, Paolo, 1990. "Rational Speculative Bubbles in an Exchange Rate Target Zone," CEPR Discussion Papers 479, C.E.P.R. Discussion Papers.
  3. Lars E. O. Svensson, 1990. "Target Zones And Interest Rate Variability," IMF Working Papers 90/31, International Monetary Fund.
  4. Beetsma, Roel M W J & van der Ploeg, Frederick, 1994. "Intramarginal Interventions, Bands and the Pattern of EMS Exchange Rate Distributions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(3), pages 583-602, August.
  5. Beetsma, R.M.W.J. & Ploeg, F. van der, 1994. "Macroeconomic stabilisation and intervention policy under an exchange rate band," Discussion Paper 1994-27, Tilburg University, Center for Economic Research.
  6. Flood, Robert P & Garber, Peter M, 1991. "The Linkage between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1367-72, November.
  7. Kempa, Bernd & Nelles, Michael & Pierdzioch, Christian, 1999. "The term structure of interest rates in a sticky-price target zone model," Journal of International Money and Finance, Elsevier, vol. 18(5), pages 817-834, October.
  8. Stefan E. Oppers, 1995. "A Model of the Bimetallic System," IMF Working Papers 95/144, International Monetary Fund.
  9. Kempa, Bernd & Nelles, Michael & Pierdzioch, Christian, 1997. "An analytical approximation of target zone exchange rate functions: the technique of collocation," Economics Letters, Elsevier, vol. 57(3), pages 339-343, December.
  10. Paul Krugman & Julio Rotemberg, 1990. "Target Zones with Limited Reserves," NBER Working Papers 3418, National Bureau of Economic Research, Inc.
  11. Bernd Kempa & Michael Nelles, 1999. "Misalignments of real exchange rates and the credibility of nominal currency bands," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 135(4), pages 613-628, December.

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