The Real Interest Rate as a Control Variable in the Open Economy

TL;DR

This paper explores the role of the real interest rate as a control variable in an open economy, analyzing its determinants and effects on wages and productivity expectations.

Contribution

It departs from standard models by treating the real interest rate as a control variable and analyzing its impact on economic variables.

Findings

Interest rate primarily determined by future utility discount rate and productivity expectations.

Increases in productivity expectations raise both interest rates and wages.

Results align with the Cass, Koopmans, Ramsey model.

Abstract

This paper addresses the structure and dynamics of an open market economy and its relations with the real interest rate. In this respect, the paper is situated within a broad conventional literature. However, it departs from the standard approach to the interest rate by treating it as a control variable. Even so, the analysis concludes that the two main determinants of the interest rate are the future utility discount rate and expectations regarding future multifactor productivity (labor efficiency). Furthermore, increases in such expectations lead to increases in both the interest rate and wages. These results are consistent with to those obtained with the Cass, Koopmans, Ramsey model.