Perfect Finance-led World Capitalism in a Nutshell

This paper considers macroeconomic real-financial market interactions in a Turnovsky (1986) two country framework with money, bonds, equities and a foreign exchange market with perfectly flexible exchange rates. It is based on conventional multiplier dynamics in its real part, augmented by either a simple LM curve or a simple Taylor interest rate policy rule, but enriched by a broad spectrum of financial assets, based in their interaction on perfect substitute and perfect foresight assumptions throughout. Contrary to Blanchard’s (1981) original contribution, we aim in this paper to analyze and solve a revised form of the model, allowing to avoid the application of the jump-variable technique of the rational expectations school, by the introduction of a Taylor policy rule that makes the dynamics convergent without the imposition of economically poorly motivated jumps of a selected number of the state variables of the model. In a final section inflation dynamics is added as in Turnovsky (1986) in order to also consider Taylor rules that are not solely concentrated on the dynamics of financial markets. ——————