Dynamics of Monetary Equilibrium Models

The analysis of temporary equilibrium allocations in Chapter 3 showed that the structural and behavioral parameters defining the type of equilibrium induce a well defined result in real and monetary terms for the macro economy in any period. In other words, for such a closed economy containing a public sector made up of a government with an integrated central bank as monetary authority supporting the system with fiat money, any feasible temporary allocation under income consistency at given money balances and expectations has an impact on the government deficit. Since government expenditure and tax revenue are endogenously determined the size and the sign of the government deficit in every period is price dependent. Therefore, changes of total money balances held in the private sector occur if and only if the government budget is not balanced. As a consequence, changes of money balances are determined simultaneously with the temporary equilibrium making them endogenous between periods. This chapter derives the main results for a recursive analysis of the development of prices, price expectations, and of money balances. The emphasis will be on characterizing and investigating the conditions under which recursive forecasting schemes exist which induce equilibrium orbits with perfect foresight and rational expectations. In addition, conditions of uniqueness of balanced paths, their stability and their basins of attraction will be examined. Some discussion will be provided for these issues with general adaptive forecasting rules.