ABSTRACT
The decision variables discussed to this point with respect to current period production of public and private goods, current labor hours, product prices, wages and the prices of pollution and harvesting rights are established before current interest rates and exchange rates are determined, thereby granting more flexibility to the determination of interest rates and exchange rates, which may vary instantly. Once the household sectors have decided the amount of public goods they want their respective government sectors to produce (and the corresponding level of taxes they are willing to pay) next period and once current period product prices and wage rates have been announced, the government sectors are free to alter their end-of-period demands for labor and capital and their end-of-period ex ante supplies of bonds in response to current bond rates. At the same time, the household sectors are free to alter their current consumption spending and their end-of-period ex ante supplies of labor and demands for currency and checkable deposits in response to changes in current interest rates on checkable deposits. In addition, once the non-financial business sectors have announced current period wages and prices and decided the level of current period output, they do not alter those values for the remainder of the current period. However, these sectors are still free to alter their financial and spending decisions for the current period in light of current bond rates and exchange rates. Therefore, we must revisit the various decision-making units in this model and construct a new set of optimization problems that take the new set of predetermined variables into account. This is done in the present chapter and the next, in which we present formal descriptions of the four banking sectors and then revisit the six non-banking sectors.
