Real-Financial Interaction: A Reconsideration of the Blanchard Model with a State-of-Market Dependent Reaction Coefficient

University of Technology, Sydney, Finance and Economics Working Paper No. 111

38 Pages Posted: 13 Feb 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: March 2001

Abstract

We reformulate and extend the Blanchard model of output dynamics, the stock market and interest rates that studies Keynesian IS-LM analysis from the perspective of a richer array of short-term bonds. Thus investment demand now depends on Tobin's average q in the place of the real rate of interest and as a result share price dynamics feed back into the real sector, thereby creating the link for the real-financial interaction studied by Blanchard. We reconsider the results achieved by Blanchard without use of logarithms and other simplifications in the expression for the substitutability and imperfect forecasts of capital gains in the place of Blanchard's limit case of perfect substitutes and myopic perfect foresight. Our more general framework, and in particular the assumption of a state-of-the market dependent speed of reaction to expected asset return differentials, allows us to develop a mode of dynamic analysis that provides an alternative to the conventional jump variable technique of the perfect limit cases. We show how as a consequence the stock market dynamics can display periods of bull and bear markets having both activated and tranquil phases that give rise to a variety of adjustment patterns.

Keywords: real-financial interaction, stability, jump variable technique, expectations, phase diagram switching, persistent fluctuations, reaction coefficient, return differential

JEL Classification: E12

Suggested Citation

Chiarella, Carl and Flaschel, Peter and Franke, Reiner and Semmler, Willi, Real-Financial Interaction: A Reconsideration of the Blanchard Model with a State-of-Market Dependent Reaction Coefficient (March 2001). University of Technology, Sydney, Finance and Economics Working Paper No. 111. Available at SSRN: https://ssrn.com/abstract=880163 or http://dx.doi.org/10.2139/ssrn.880163

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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