ABSTRACT
This chapter focuses on the possible instabilities in the financial sector. Using a portfolio approach based on the work by James Tobin (1982), one can identify the sources of financial market instability and the feedback channels from the financial to the real markets and vice versa. Furthermore, due to the extension of the portfolio model through long-term bonds as an additional risky asset for which capital gains have to be taken into account. Financial slumps and extensive real recessions are not unique events in economic history, but recurrent features of capitalist economies. The chapter considers policies to stabilize a financially unstable economy. These policy measures are, for example, a Tobin-type tax on capital gains for long-term bonds as well as equities, certain interest rate policy rules concerning equity prices and long-term bond prices and also open market operations of the central bank in the market for long-term bonds.
