Finance Discipline Group
UTS Business School
University of Technology, Sydney

Working Paper Series

Title:
Output and the Term Structure of Interest Rates: Ways Out of the Jump-Variable Conundrum
Author(s): Carl Chiarella, Peter Flaschel, Reiner Franke & Willi Semmler
Date of publication: April 2003
Working paper number: 125
Abstract:
In this paper we reconsider a model of Blanchard and Fisher which reformulated Keynesian IS-LM analysis from the perspective of a richer array of financial assets, namely short-term and long-term bonds, and thus from the perspective of the term structure of interest rates. The basic change in this extension of the IS-LM approach is that investment demand (and also consumption demand) now depend on the long-term rate of interest in the palce of the short-term rate. This implies that the IS-curve and the LM-curve are no longer situated in the same diagram, but have to be linked via the dynamics of long-term bond prices (in the approach of Blanchard and Fischer based on perfect substitutes, perfect foresight and the jump variable technique), thereby creating one of the links for the real-financial interaction to be investigated, the dynamic multiplier process and thw conventional LM curve representing the other one. Based on this dynamic interaction of real and financial markets we will reflect the outcomes achieved by Blanchard and Fischer from the perspective of imperfect substitutes and mypoic perfect foresight. We derive on this basis alternatives to the conventional jump variable technique and its treatment of unanticipated and anticipated monetary and fiscal policy, which are global in nature and do not depend on well-behaved stable manifolds in an essentially local analysis of saddlepoint instability as in the case for the jump variable technique.
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Known citations: Chiarella, C., Flaschel, P. and Semmler, W., 2003, "Real-Financial Interaction: Implications of Budget Equations and Capital Accumulation", Working Paper Number: 127, Finance Discipline Group, University of Technology, Sydney.