ABSTRACT
In this chapter we integrate the macroeconomic real…“nancialmarket interactions studied in Chapters 2 and 4, the Blanchard output and stock market dynamics, and the Dornbusch price level and exchange rate dynamics. We will investigate whether their interaction gives rise to new results for the rational expectations approaches as they were analyzed above in the two preceding chapters. We can do this here in a two-country framework with domestic and foreign money, bonds, equities and a foreign exchange market with a ”exible exchange rate.1
The model uses at “rst solely conventional multiplier dynamics in its real part, as in Blanchard (1981),2 augmented by either a simple LM curve or, later on, by a simple Taylor interest rate policy rule. This is enriched throughout by a broad spectrum of domestic and foreign “nancial assets, based on their dynamic interaction under the assumptions of perfect substitute and perfect foresight. The implied 5D dynamics (with bond dynamics in the background of the model) is, like the one studied in Chapter 2, intrinsically nonlinear and dif“cult to analyze even from a local perspective,3 since it exhibits three forward-looking variables and two predetermined ones. Thus the stable manifold must again be of dimension 2 for the jump variable technique to be applicable.
