Suppose there is no intertemporal substitution effect of the real interest rate on consumption, and that...
Suppose there is no intertemporal substitution effect of the real interest rate on consumption, and that investment spending does not respond to the real interest rate. What would this imply for the real business cycle model’s ability to explain the key business cycle facts? Explain.
Homework Answers
Elasticity of intertemporal substitution is an important determinant of the response of saving and consumption to the real interest rate. In real business cycle theory , most of the business cycle fluctuations can be accounted for by real shocks. This model suggests that technological advances and the changes in productivity are two of the main causes of macroeconomics fluctuations in the economy.
If there is no intertemporal substitution effect of the real interest rate on consumption and investment spending does not respond to the real interest rate , then this will hamper the ability of the real business cycle model to explain the key business cycle facts. As Real buisiness cycle theory uses intertemporal substitution to explain the fluctuations in the market.
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