A dynamic model of real-financial markets interaction

The global recession brought on by the financial crisis and the COVID-19 pandemic has reignited interest in understanding the relationship between business cycles and financial conditions. This paper proposes a macrodynamic model that captures the interaction between the stock market (SM) and the economy's real sector (RS), which is fueled by two distinct sources of persistent fluctuations. The SM incorporates two types of speculators, namely, chartists and fundamentalists, whereas the RS is a simplified version of Goodwin's growth cycle model that distinguishes between labor and capital incomes. This framework connects the chartist–fundamentalist literature to Goodwin's model for the first time. The interaction is based on two key assumptions: (i) investment decisions are influenced by profits and stock prices, and (ii) speculators perceive the fundamental value of the stock as proportional to national output. This interaction of real and financial dynamics causes fluctuations due to the sensitivity of investment to stock prices and the proportionality between stock fundamentals and output.