A stylized macro-model with interacting real, monetary and stock markets

Abstract

We propose a model economy consisting of interdependent real, monetary and stock markets. The money market is influenced by the real one through a standard LM equation. Private expenditures depend on stock prices, which in turn are affected by interest rates and real profits, as these contribute to determine the participation level in the stock market. An evolutionary mechanism regulates agents’ participation in the stock market on the basis of a fitness measure that depends on the comparison between the stock return and the interest rate. Relying on analytical investigations complemented by numerical simulations, we study the economically relevant static and dynamic properties of the equilibrium, identifying the possible sources of instabilities and the channels through which they spread across markets. We aim at understanding what micro- and macro-factors affect the dynamics and, at the same time, how the dynamics of asset prices, which are ultimately influenced by the money market, behave over the business cycle. Starting from isolated markets, we show the effect of increasing the market interdependence on the national income, the stock price and the share of agents that participate in the stock market at the equilibrium. Moreover, we investigate the stabilizing/destabilizing role of market integration and the possible emergence of out-of-equilibrium dynamics.