ABSTRACT
In the present chapter, we combine the various sectoral demand and supply functions for financial assets that we have derived in preceding chapters to form competitive markets for checkable deposits in both the home and foreign countries as well as competitive markets for the bonds issued in both the home and foreign countries. We are able to solve for equilibrium interest rates in these four markets in a block-recursive fashion, since, in this model, current interest rates on checkable deposits affect current bond rates, but current bond rates do not affect current rates on checkable deposits. Once we have presented the equilibrium conditions for home and foreign bonds separately, we derive a locus, depicting, for a given spot rate, the combinations of the forward exchange rate and the home and foreign bond rates consistent with simultaneous equilibrium in both bond markets.
