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The Economics of Imperfect Markets pp 137–166Cite as

The Macroeconomics of Imperfect Capital Markets: Whither Saving-Investment Imbalances?

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Abstract

Starting with Wicksell and until the heyday of Keynesian economics, inflation, unemployment and business cycles were thought and taught mainly as problems originating from “saving-investment imbalances” due to some form of malfunctioning of the capital market. Whereas modern studies of imperfect capital markets have greatly improved our understanding of capital market failures, their impact on macroeconomics has remained surprisingly limited. The macroeconomic consequences of saving-investment imbalances are still undeveloped in this literature. The most popular macroeconomic model to date – the so-called New Neoclassical Synthesis – dispenses with capital market imperfections altogether. The aim of this paper is to fill this gap. After an overview of the historical foundations and the current state of the macroeconomics of imperfect capital markets, the paper presents a competitive, flex-price model of saving-investment imbalances where deviations of the market interest rate from the Wicksellian natural rate generate (disequilibrium) business cycles. Then the model is extended to make the market interest rate endogenous and to allow preliminary considerations to be made about monetary policy and the control of the interest rate over the business cycle.

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Notes

  1. 1.

    A more comprehensive overview can be found in Delli Gatti and Tamborini (2000).

  2. 2.

    Thus this model can be viewed as a modern explanation of the role of banks in Wicksell’s theory of saving-investment imbalances.

  3. 3.

    Recall the model by De Meza and Webb mentioned in Section Underinvestment and Overinvestment.

  4. 4.

    According to standard DSGE methodology these variables may change over time owing to random shocks to the underlying parameters. This feature is inessential for present purposes.

  5. 5.

    As a matter of fact, recurrent estimates of the output/unemployment and inflation functions invariably find these features. See Orphanides and Williams (2002, 2006) and Caresma et al. (2005) for a survey. These empirical regularities are not easily accommodated within a model whose hallmark is the role of so-called forward-looking output and inflation functions, unless the model is filled with additional ad hoc “frictions” (Chiarella et al. 2005, chs. 1 and 8, offer a thorough discussion). However, the time structure of our equations 0-0 are not due to backward-looking behavior or other frictions. On the contrary, they result from the correct consideration of the feed-foward effects of saving-investment imbalances.

  6. 6.

    “While Wicksell had refused to use his theory of cumulative processes for the explanation of industrial fluctuations, [it was] Lindahl [who] wanted to extend Wicksell’s approach into a general theory of business cycle” (Boianovsky and Trautwein 2006, p. 8). Lindahl (1939) in fact included unemployment in his analysis, foreshadowing the modern distinction between cyclical and structural unemployment (Lindahl 1939, p. 11).

  7. 7.

    At the time when Wicksell was writing, there was already clear evidence that nominal interest rates would tend to move together with the GPL (see e.g., the diagrams in 1898a) – a phenomenon later labelled the “Gibson paradox” by Keynes. Wicksell argued that this phenomenon would not contradict his theory, but that it was instead to be explained as the ongoing adjustment process of nominal interest rates towards a new level consistent with the steady-state level of prices.

  8. 8.

    The typical LM function is obtained by starting from a log-linear money demand function,

    ${m}_{t}^{d} = {\mu }_{y}{y}_{t} - {\mu }_{ i}{i}_{t}$

    Equating money demand to real money supply, m t  − p t , the equilibrium interest rate is

    ${i}_{t} = ({\mu }_{y}\ /\ {\mu }_{i}){y}_{t} - (1\ /\ {\mu }_{i})({m}_{t} - {p}_{t})$
  9. 9.

    This line of research is actively pursued, for instance, by Orphanides and co-authors (Orphanides and Williams 2002, 2006).

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Acknowledgements

I wish to thank Axel Leijonhufvud, Vela Velupillai, Edoardo Gaffeo, Andrea Fracasso, Ronny Mazzocchi and Hans Michael Trautwein for helpful discussions and comments. Financial support is acknowledged to the Italy-Germany Inter-Univeristy “Vigoni Programme,” 2006–2007.

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  1. Department of Economics, University of Trento, Via Inama 5, 38100, Trento, Italy

    Roberto Tamborini

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  1. Roberto Tamborini
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  1. D.E.M.Q, Università di Urbino, Via Saffi 42, Urbino, 61029, Italy

    Giorgio Calcagnini

  2. Dipto. Economia Pubblica, Università di Roma, Via del Casatro Laurenziano 9, Roma, 00161, Italy

    Enrico Saltari

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Tamborini, R. (2010). The Macroeconomics of Imperfect Capital Markets: Whither Saving-Investment Imbalances?. In: Calcagnini, G., Saltari, E. (eds) The Economics of Imperfect Markets. Contributions to Economics. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-2131-4_8

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