Reiner Franke

Exchange Rate Volatility

In chapter 2 we have considered a monetary model with completely flexible prices and in chapter 3 contrasted this model type with a fixed price model where quantities rather than prices adjusted in order to clear the markets for the domestically produced and the foreign good. The flexprice approach may be considered the earliest in the study of international trade and balance of payments adjustments, while the Keynesian international multiplier analysis was of course only developed after the appearance of Keynes ‘General Theory’ in 1936 and in particular after World War II. The monetary model had a brief renaissance in the early 1970s when the Bretton Woods system came to an end. It was supposed to provide an alternative to the prevailing fixprice macrotheory of Mundell-Fleming type and proposed the establishment of a system of flexible exchange rates. Yet, exchange rates proved to be much more volatile after the breakdown of the Bretton Woods system in 1973 than was predicted by the monetary model. Confronted with such findings the immediate success of another model type, the Dornbusch (1976) model of sticky, but not fixed prices and flexible, in fact too volatile exchange rates in an environment of high capital mobility, can easily be understood.1 The seminal Dornbusch (1976) model2 combines stock and flow equilibria on the asset markets (money, domestic and foreign bonds respectively) with sluggishly adjusting prices on the market for goods and in later extensions also on the market for labor. Money supply shocks thereby enforce overreaction of the domestic interest rate and as a consequence also of the exchange rate, with respect to their new steady state values, and only after some time are eliminated by subsequent convergence to their (new) steady state values. In appropriately revised form the Dornbusch approach can be viewed to be composed of short-run Mundell-Fleming elements, a new type of exchange rate dynamics, and long-run Classical features (neutrality of money and the relative form of the PPP). It therefore synthesizes to some extent the three preceding chapters of this part of the book by providing an IS-LM-PC approach to the dynamics of exchange rates and expectations of exchange rate depreciation or appreciation with a Classical long-run outlook.

Behavioural Heterogeneity under Evolutionary Pressure: Macroeconomic Implications of Costly Optimisation

A model is developed in which a continuum of agents makes interdependent output decisions in a stochastic environment characterized by strategic complementarity. Two groups are distinguished: naive agents follow a costless adaptive expectations rule, while sophisticated agents incur an optimization cost to achieve self-fulfilling expectations. The paper studies the dynamics generated as the population composition evolves under pressure of differential payoffs. Sophisticated agents are favored if optimization is cheap or the stochastic environment highly variable but naive agents generally persist. A higher long-run share of sophisticated agents is associated with greater output variability and low output persistence. Copyright 1995 by Royal Economic Society.

A Metzlerian model of inventory growth cycles

Abstract The paper proposes an elementary macroeconomic growth model in which the evolution of inventories can be studied in combination with the accumulation of fixed capital. Inventory investment is specified along Metzlerian lines, while expected sales are determined by an adaptive expectations mechanism. Alternatively, myopic perfect foresight is considered. It is argued that the steady state position is typically unstable. Employing a flexibility condition for the stock-adjustment speed of inventories ensures convergence to periodic growth cycles. Finally, the model is calibrated such that the numerical simulations are largely compatible with empirical time series.

Converse trading strategies, intrinsic noise and the stylized facts of financial markets

This paper proposes a simple asset pricing model with three groups of traders: chartists who believe in the persistence of bull and bear markets, fundamentalists who bet on a reduction of the observed mispricing, and investors who follow a buy-and-hold strategy. The innovative feature of the model concerns the frequency of trading: rather than remaining constant over time, each agent in a group is only assumed to become active with a certain probability over a given market period. Depending on the trading strategy, part of this elementary kind of intrinsic noise is additive and another part is multiplicative. Using bootstrap and Monte Carlo methods, it is demonstrated that this combination can contribute to explaining the stylized facts of the daily returns on financial markets, such as volatility clustering, fat tails, and the autocorrelation patterns.

Reinforcement learning in the El Farol model

Abstract The paper applies the approach of reinforcement learning to Arthur’s [American Economic Review 84 (1994a) 406] El Farol problem, where repeatedly a population of agents decides to go to a bar or stay home, and going is enjoyable if, and only if, the bar is not crowded. The numerical simulations show that the learning process is fairly efficient in that attendances tend to fluctuate around the bar’s capacity. On the other hand, the shape of the long-run equilibrium frequency distribution is usually quite distinct from the Nash equilibrium solutions and furthermore rather sensitive to some of the model’s specification details.

A Keynes-Goodwin model of the business cycle

Abstract The paper puts forward a dynamic IS-LM model in four state variables representing real balances, inflation, income distribution, and a so-called state of confidence. Local (in)stability is characterized by (high) low interest elasticities of money demand. Also a Hopf bifurcation can be shown to exist. Freezing inflation and distribution makes a mathematical analysis of the main stability mechanisms in the outer regions possible. The global dynamics of the full system is studied by means of numerical simulations. It gives rise to unique and stable limit cycles. Lastly, a sensitivity analysis inquires into the impact of parameter changes on the main cycle features.

Two Destabilizing Strategies May Be Jointly Stabilizing

The paper contributes to the literature on learning dynamics with heterogeneous agents, demonstrating that heterogeneity as such may be conducive to stability. The point is made in the framework of the cobweb model, where two different forecast procedures are considered. Either one destabilizes the price dynamics when it is uniformly adopted by all firms, or the price equilibrium becomes locally stable if firms are heterogenous and the two rules are suitably mixed within the population. It is also indicated that such a stabilizing composition is endogenously brought about by an adjustment process in which the population shares evolve under evolutionary pressure.

Optimal Utilization of Capital and a Financial Sector in a Classical Gravitation Process

In a production price framework, a two-sectoral gravitation process with cross-over adjustments of prices and quantities is advanced. To overcome an inconsistency in the treatment of fixed capital in disequilibrium, the socio-technological input coefficients are assumed to vary with the sectoral output-capital ratio, such that for each relative price there exists an optimal degree of capital utilization which maximizes the sectoral rate of profit. Production prices prevail if these maximizing rates of profit are equalized. In addition, a financial sector determining the rate of interest is incorporated into the model. The mathematical analysis establishes a broad scope for local stability of the long-run equilibrium position once a condition applies that ensures stability of the output adjustments in the short period.

Can monetary policy tame Harrodian instability

The paper introduces monetary policy into the canonical Kaleckian growth model with a built-in Harrodian instability. It abstains, however, from the simple and immediately stabilizing interest rate inverse IS curve. Instead, more indirect effects are examined, which realistically will take time to work out. In particular, (a) the trend rate of growth governing the investment decisions additionally responds to the difference between the profit rate and the real rate of interest; and (b) the real interest rate may enter dynamic adjustments of the price markup. The main finding is that the Harrodian forces could still be overcome and stability of the steady state position is re-established provided that the profitability motive in (a) and the responsiveness in the Taylor policy rule are both sufficiently strong. By contrast, the indirect feedback effects produced by (b) broaden the scope for instability. In sum, monetary policy in this extended framework can favour stability but is not necessarily the stabilizing panacea that the New Consensus considers it to be.

Technical Change and a Falling Wage Share if Profits are Maintained

In the framework of a multi-sectoral and fixed-coefficients Leontief model with capital stock matrix B, the paper addresses the issue of the impact of technical change on income distribution. Comparing two steady-state positions, it is shown that with cost-reducing, capital-using and (uniformly) labour-saving technical change the equilibrium rate of profit will fall, if it is the aggregate wage share which remains fixed, not the absolute level of the real wage. Conversely, the wage share falls if the profit rate does not change. The reactions are ambiguous if, instead of the coefficients of the matrix B, the coefficients of the input–output matrix A increase.