Real-Financial Interaction: Implications of Budget Equations and Capital Accumulation

Carl Chiarella (), Peter Flaschel and Willi Semmler ()
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Peter Flaschel: Department of Economics, University of Bielefeld

No 127, Working Paper Series from School of Finance and Economics, University of Technology, Sydney

Abstract: We investigate the real-financial interaction of an approach of Blanchard to stock market and multiplier dynamics from the stock-flow consistency perspective by including the capacity and the financing effect of the investment decision of firms into the model. We show that the steady state solutions of the Blanchard approach are no longer of relevance here, but rather are replaced by a unique interior long-run solution. We demonstrate asymptotic stability with respect to this steady state when stock market adjustments is sufficiently sluggish, and this even in the case of myopic perfect foresight. In the opposite situation, if stock markets adjustments is made sufficiently fast, the system loses stability by way of a Hopf bifurcation for increasing adjustment speeds of capital gains expectations and will generate purely explosive behavior shortly thereafter. We indicate for this case how a regime (or phase diagram) switching methodology between activated and tranquil stock market behavior may nevertheless ensure global viability of the dynamics, despite the occurence of shorter of longer episodes of explosive financial acceleration, by assuming that stock markets must return to tranquillity after certain thresholds are passed, where financial acceleration due to high adjustment speeds in the market for equities disappear.

Keywords: real-financial interaction; stability; hopf-bifurcations; jump-variable methodology; phase diagram switches (search for similar items in EconPapers)
JEL-codes: E12 E43 E44 (search for similar items in EconPapers)
Date: 2003-05-01
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