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

Carl Chiarella, Peter Flaschel and Willi Semmler

No 111, Working Paper Series from Finance Discipline Group, UTS Business School, University of Technology, Sydney

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 (search for similar items in EconPapers)
JEL-codes: E12 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2001-03-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Chapter: Real-Financial Interaction: A Reconsideration of the Blanchard Model with a State-of-Market Dependent Reaction Coefficient (2004)
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