Clearly, the new equilibrium is at point E1 and the only path to this point is the saddle path going through it. Since K is fixed in the short run, the only stable adjustment path is the one with a "financial correction" at the time of the occurrence of the shock (in tA ): q jumps down from point E0 to point A directly below it. The intuition behind this financial correction is aided by solving the differential equation for q given in (4.14):

0o r q(t)fFK(r) exp[— [r(s) + 6] dddrf (4.24)

Hence, as was already hinted at above, q represents the discounted value of present and future marginal products of capital, so that an increase in r (either now or in 44 AA 4 Aed...•, 4 mostaiate fmancial _.s t u..

anal example c ar --it of .a x>.cdulec sik Isom to occur at sou et --tee : L.

-.Appals to the value u becx af.;,./a11:« -

Millabie. But by ho-.

: :311.

arm at the time the a

T an ie (shad maul h .eshn, 90 K= 0 A

4 Chapter 4: Anticipation Effects and Economic Policy K Ko q

= 0)1 go

— 4 = 0 Ko K

K, A :

A ri TO time

^Pnt ustment over time has also er an unanticipated permaated in Figure 4.4. Equation he heavier discounting of ament path look like now?

path to this point is the run, the only stable adjuste time of the occurrence of rectly below it. The intug the differential equation

(4.24)

I ifcounted value of present se in r (either now or in tA -= t, time