Output and the Term Structure of Interest Rates: Ways Out of the Jump-Variable Conundrum

UTS School of Finance and Economics Working Paper No. 125

38 Pages Posted: 21 Jan 2006

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics

Reiner Franke

Vienna University of Technology

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Date Written: April 2003

Abstract

In this paper we reconsider a model of Blanchard and Fisher 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 palce 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 thw 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 mypoic perfect foresight. We derive on this basis alternatives to the conventional jump variable technique and its treatment of unanticipated and anticipated monetary and fiscal policy, which are global in nature and do not depend on well-behaved stable manifolds in an essentially local analysis of saddlepoint instability as in the case for the jump variable technique.

Keywords: real-financial interaction, term structure of interest rates, jump variable technique, postulated stability, relaxation oscillations, phase diagram switching

JEL Classification: E12, E43, E44

Suggested Citation

Chiarella, Carl and Flaschel, Peter and Franke, Reiner and Semmler, Willi, Output and the Term Structure of Interest Rates: Ways Out of the Jump-Variable Conundrum (April 2003). UTS School of Finance and Economics Working Paper No. 125. Available at SSRN: https://ssrn.com/abstract=877225 or http://dx.doi.org/10.2139/ssrn.877225

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany

Reiner Franke

Vienna University of Technology ( email )

Wien 1040
Austria

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universit├Ątsstra├če 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

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