ABSTRACT
Expressions (11.09), (11.20) and (11.21) are useful not only in obtaining alternative expressions for a nation's balance of payments, but also in solving the system of equations associated with the world's financial markets. In Chapter 8, we found that the market for checkable deposits denominated in the home country's unit of account and the market for checkable deposits denominated in the foreign country's unit of account are independent of the interest rates on home and foreign bonds as well as of the spot and forward rates. Therefore, the first step toward solving the financial markets involves finding the interest rates on home and foreign checkable deposits that clear those two markets and then substituting these equilibrium interest rates into the expressions for the equilibrium conditions for home and foreign bonds, home and foreign currency, spot contracts and forward contracts. Then, given that both markets for checkable deposits clear this period and that the forward contract market cleared last period, Walras's Law implies:
t+I t+I t+I t+I t t t+I t+I t+I t+I (12.01)
According to this restriction, at most three of the four equilibrium conditions associated with the markets for home and foreign bonds and home and foreign currency are linearly independent. Although this restriction is informative, we shall elect to view the interest rates on home and foreign bonds as being established in the respective markets for these bonds. In addition, we prefer to view the spot exchange rate as being established in the spot market and the forward exchange rate as being established in the
as as
t+l t+l t t t+l t+l (12.02)
t t t+ 1 t+1 t t+l
as
as as as
utilize the projections upon the (rh, E) and (rh+, E) coordinate planes of the lines of intersection which we derived as the BB+, SF and CC+ loci. The BB+ line, developed in Chapter 8, shows the combinations of rh, rh+,
and E consistent with simultaneous equilibrium in the home and foreign bond markets. The SF line, derived in Chapter 9, shows the combinations of rh, rh+, and E consistent with simultaneous equilibrium in the spot and forward markets for foreign exchange. The C+C line, obtained in Chapter 10, indicates the combinations of rh, rh+, and E consistent with simultaneous equilibrium in the market for home and foreign currency. A "general equilibrium" in these financial markets refers to a situation in which all three projections upon both coordinate planes intersect at the same combination of rh, rh+, and e, assuming a common value of the spot rate is held constant in positioning all these projections.
