The real interest rate and aggregate supply

Abstract

This paper analyzes the effects of the anticipated real interest rate on aggregate supply variables, in a model where time-to-produce and variable capital utilization play a crucial role. The potential importance of the present mechanism for business cycle theory lies in its ability to generate positive co-movements of employment, capital utilization, labor productivity, output and investment. These variables are predicted to be affected negatively by the real interest rate. Reduced forms for output and employment are derived and tested with Canadian data, taking estimates of the real interest rate prevailing in the United States as the relevant exogenous price.

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