Our aim is to understand the main stabilizing and destabilizing economic forces driving the dynamics of the model and to analyze their potential to generate complex dynamic behavior.
In Section 14.2 we lay out and motivate the eight differential equations governing the dynamics of our model. In Section 14.3 we discuss the ﬁve main economic feedback chains, the Rose effect, the Mundell effect, the Metzler effect, the Dornbusch effect and the Keynes effect, and show that their conﬂicting stabilizing and destabilizing inﬂuences drive the dynamic behavior of the model. We show that eigenvalue analysis indicates that local stability is lost via Hopf bifurcations in a way that is dependent in particular on the speeds of adjustment of prices and expectations. In this section we also discuss the intrinsic (or “natural”) nonlinear features of the model. Simulations reveal however that the aforementioned intrinsic nonlinearities are generally not sufﬁcient to bound the dynamics when the equilibrium is locally unstable. Therefore in Section 14.4 we introduce (and motivate) an extrinsic nonlinearity into the function modeling net capital ﬂows by taking account of the fact that these are bounded by international wealth. This extrinsic nonlinearity in conjunction with rapid speeds of adjustment of exchange rates and of expectations of exchange rate depreciation give rise (close to the limiting case of myopic perfect foresight) to a relaxation oscillation between the exchange rate and its expected rate of depreciation. Simulations reveal that movements away from the locally unstable equilibrium remain bounded on some sort
of complex attractor. However high-frequency movements in the foreign exchange sector here lead to unrealistic high-frequency movements in the real sector of the model.