Abstract
In order to better understand relationships between the real economy and financial economy, it is necessary to formulate a model of financing. New Keynesian theory emphasizes that a firm’s net worth influences investment decisions and business cycles under an imperfect capital market. We have constructed a dynamic model from the standpoint of post Keynesian economics. We incorporate a dynamic equation of a firm’s net worth ratio and investigate financial factors, which give rise to economic instability. Our results demonstrate that a steady state can be a saddle point when the dividend rate is low and the bank’s lending reaction to the net worth ratio is more elastic than investment reaction. When the steady state is the saddle, the change in the basic discount rate is likely to shift the economy from an unstable path to a convergence path. Financial policy has a stabilizing effect in the long-run as well as a positive effect in the short-run. JEL Classification:E12, E44, E52.
Highlights
Financial markets in market economies gain in complexity and have significant effects on the real economy
Keynes [10] rejected classical economics and indicated the instability of the real economy; especially, he emphasized the instability of financial markets
We investigate the effects of monetary policy on the short-run and long-run equilibrium; especially, we consider a stabilizing effect of monetary policy when the steady state is unstable
Summary
Financial markets in market economies gain in complexity and have significant effects on the real economy. He is in the post Keynesian group, which emphasizes instability of the economy He investigated the financing of investments and the cyclical behavior of the real economy. We first construct a static model, and extend to a dynamic model that incorporates dynamic equations of both the net worth ratio and bank lending rate.2 This dynamic model is similar to that of Taylor and O’Connell and Adachi. Our results demonstrate that the economy can be unstable when the dividend rate is low and the bank’s lending reaction to the net worth ratio is more elastic than investment reaction. The latter factor is a feature of our model.
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