ABSTRACT
The primary purpose of this study has been to construct a general dynamic two-country model of the world economy, based upon explicit first principles, that emphasizes the fundamental roles played by the major sectors and the various markets in that economy. The model presented here indicates that the New Classical notion that current output is independent of current aggregate demand is consistent with the New Keynesian notion that aggregate demand nevertheless matters with respect to the (future) costs of producing and supplying goods and, therefore, with respect to (future) production. In addition, we have shown that while current financial markets do not necessarily affect current output, they nevertheless do affect future production costs and relative factor prices. Because these costs influence the factor combinations and the scales of plant around the world in the future, current financial markets affect the time paths of real investment and production worldwide.
