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Macroeconomic stabilization policies in intrinsically unstable macroeconomies

Abstract:

Many monetary and fiscal policy measures have aimed at mitigating the effects of the financial market meltdown that started in the U.S. subprime sector in 2008 and has subsequently spread world wide as a great recession. Slowly some recovery appears to be on the horizon, yet it is worthwhile exploring the fragility and potentially destabilizing feedbacks of advanced macroeconomies in the context of a framework that builds on the ideas of Keynes and Tobin. This framework stresses the fragilities and destabilizing feedback mechanisms that are potential features of all major markets-those for goods, labor, and financial assets. We use a Tobin macroeconomic portfolio approach and the interaction of heterogeneous agents on the financial market to characterize the potential for financial market instability. Though the study of the latter has been undertaken in many partial models, we focus here on the interconnectedness of all three markets. Furthermore, we study what potential labor market, fiscal and monetary policies can have in stabilizing unstable macroeconomies. In order to study this problem we introduce, besides money, long term bonds and equity into the asset market. We in particular propose a countercyclical monetary policy that sells assets in the boom and purchases them in recessions. Modern stability analysis is brought to bear to demonstrate the stabilizing effects of the suggested policies. The policies suggested here could help the Fed in its search for an appropriate exit strategy after its massive intervention in the financial market. © 2012 De Gruyter.