ABSTRACT

In this chapter, we now introduce …in contrast to Chapter 11 …a Keynesian demand constraint on the market for goods in place of the assumption of some sort of Say•s law that we used in the previous chapter (according to which the world market delivered or consumed everything not present or not needed in the domestic economy). This will be done by adding a net export function (and now also an investment function) to the description of aggregate goods demand. In addition, we now also assume imperfect substitutability of “nancial assets in place of the UIP condition of the previous chapter. This imperfectness is here coupled with the assumption that domestic bonds are nontradables; i.e., the amount of foreign bonds held domestically can only be changed to the extent that there is a surplus or a de“cit in the current account and not via balanced exchanges of domestic bonds against foreign ones (or vice versa). International capital movements of this sort will be the subject of the Chapter 15 of this book. Finally, we will now assume regressive expectations formation in the place of rational expectations, which has two effects: on the one hand, it avoids the questionable jump variable technique of the rational expectations school (in order to get stability in an otherwise unstable saddlepoint environment) and, on the other hand, it allows for maximum stability of the dynamics in question, since only fundamentalist and, in principle, converging expectations revisions are allowed for.