The basic deterministic macroeconomic model

The main purpose of this chapter is to build and explore a benchmark macro-model in a deterministic setting of financial markets. Although this model exhibits highly unrealistic features like a constant short-term interest rate and thus a flat term structure of interest rates, it has nevertheless some merits: first of all, the income and debt dynamics are linear so that we can calculate and analyze the time paths of these variables explicitly. This delivers clear-cut results with regard to economic growth and public indebtedness. Second, the stochastic macro-model to be developed later on converges to this deterministic version when risk disappears. We can check the correctness of the reduced-form dynamics of our stochastic model by simply looking at the deterministic model. Third, by comparing the outcomes of the stochastic version with the deterministic one, we can discern the qualitative effects brought about by the introduction of risk.