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Based on Paul Krugman

This model, based on Paul Krugman, simplifies by assuming capital does not consume, and labor does not save. It explores GDP, aggregate demand, credit constraints, and capital markets, focusing on credit-constrained investment. The interactions lead to equilibrium conditions and a loop system.

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Based on Paul Krugman

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  1. A THIRD-GENERATIONMODEL OF BOP CRISES:Interactions among balance-sheets, real exchange rate and investment Based on Paul Krugman

  2. A simplifying assumption: CAPITAL DOES NOT CONSUME AND LABOR DOES NOT SAVE. GDP Aggregate demand Real exchange rate:

  3. Credit constraints: Simplifying assumption: capital input enters production with one-period lag. Inputs’ markets are competitive Capital markets: arbitrage

  4. Credit-constrained investment: Actual (incentive-based) investment Expected (aggregate) investment

  5. I-actual 45-DEGREE H L I-expected

  6. If p is pegged, y becomes endogenous That is, two equilibria, as in the Figure for the case where p is not pegged

  7. One unit of capital good: A price index Capital input is an intermediate good

  8. First-order conditions:

  9. A NEOCLASSICAL EQUILIBRIUM: THE HORIZONTAL LINE-SEGMENT: Given. Note: This explains the horizontal segment-line in the figure. is NOT varying with changes in

  10. Investment evaluated at current prices The neoclassical segment Recall that p is negatively related to

  11. H L

  12. MITIGATING EFFECT: CAPITAL INVESTMENT ENTERS PRODUCTION WITH NO LAGS

  13. Note: the transfer problem works through both supply and demand changes Thus, dW/dI gets smaller as the investment-lag is reinstated (the previous case).

  14. Pegged real exchange rate y becomes demand-determined! A loop: W depends on y, which in turn depend on I; I depends on W through supply of credit.

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