We solve a version of the analytical Real Business Cycle (RBC) model with a predetermined rate of return on household saving. The solution differs from that of the benchmark RBC model along two dimensions: (i) Policy functions depend on the variance of the technology shock. (ii) There is a suboptimal pattern of excess saving. We discuss the economic intuition underlying these properties. We also demonstrate that unconditional welfare can be higher in the suboptimal model with predetermined interest rates, providing a clear illustration of the pitfall with unconditional welfare comparisons.
RBC model; predetermined interest rates; over-saving; conditional and unconditional welfare;
- E21: Consumption • Saving • Wealth
- E32: Business Fluctuations • Cycles
- E43: Interest Rates: Determination, Term Structure, and Effects
Patrick Fève, Alban Moura, and Olivier Pierrard, “Predetermined Interest Rates in a Analytical RBC model”, TSE Working Paper, n. 18-954, September 2018.
Patrick Fève, Alban Moura, and Olivier Pierrard, “Predetermined Interest Rates in a Analytical RBC model”, Economics Letters, vol. 172, November 2018, pp. 12–15.