ABSTRACT
Next, we reconsider a textbook model of Blanchard and Fischer (1989, 10.4) who reformulated Keynesian IS…LManalysis from the perspective of a richer array of “nancial assets, namely short-term and long-term bonds, and thus from the perspective of the term structure of interest rates.1 The basic change in this extension of the IS…LMapproach is that investment demand (and also consumption demand) now depends on the long-term rate of interest instead 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, via perfect foresight and the jump variable technique). This creates one of the links for investigating real…“nancialinteraction, the dynamic multiplier process and the conventional LM curve representing the other link. On the basis of this dynamic interaction of real and “nancial markets we will re”ect the outcomes found by Blanchard and Fischer (1989) from the perspective of imperfect substitutes and imperfect forecasts of capital gains, replacing their limit case of perfect substitutes and myopic perfect foresight. On this basis, we derive two alternatives to the conventional jump variable technique and its treatment of unanticipated and anticipated monetary and “scal policy. Our results are global in nature and do not depend on the essentially local2analysis of saddlepoint stability as is the case for the jump variable technique.
