Imperfect Knowledge, Asset Price Swings, and Structural Slumps
Imperfect Knowledge, Asset Price Swings, and Structural Slumps
A Cointegrated Vector Autoregressive Analysis of Their Interdependence
This chapter examines the relationship between speculation in the currency markets and aggregate activity in the real economy by drawing on the Structural Slumps theory and the theory of Imperfect Knowledge Economics (IKE). It first considers exchange rate determination in two models, one based on the Rational Expectations Hypothesis (REH) and the other on the theory of IKE, before discussing some general principles for how to structure the observed persistence in the data, and how these principles can be used in the cointegrated vector autoregressive model. The chapter also explains how foreign currency speculation under IKE interacts with a customer market economy where profit shares are adjusting to fluctuations in real exchange rates and where the natural rate of unemployment is a function of nonstationary real long-term interest rates.
Keywords: speculation, currency markets, structural slumps, Imperfect Knowledge Economics, Rational Expectations Hypothesis, cointegrated vector autoregressive model, real exchange rates, customer market economy, unemployment, long-term interest rates
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