chapter  1
39 Pages

Models of growth, inflation and the real-financial market interaction

The dominant tradition on the intermediate textbook level is to make use of the conventional IS-LM model of the real-financial market interaction to describe the short-run behavior of a closed economy on the macrolevel, while the medium run and inflation dynamics are modeled by amonetarist variant of this model type. For the long run, one, however, makes use of the real Solovian growth dynamics, the nonmonetary neoclassical growth model, in order to describe the basic forces of economic growth. The IS-LM equilibrium for output and interest is an attracting equilibrium if ‘ultra-short-run’ adjustment rules for output and the nominal rate of interest are added to this modeling framework; the steady state of the monetarist inflation dynamics of the medium run is attracting, since the interaction between the real rate of interest channel and the dynamics of inflationary expectations are modified in various ways in order to suppress the destabilizing Mundell effect; and the long-run balanced growth path of the Solow model is attracting, since one reduces everything here to the adjustment of the full-employment capital intensity state variable (by totally ignoring the unemployment models of the short-and the medium-run).