Effects of Interest Rate Shock on Business Cycle and Growth
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| Title | Effects of Interest Rate Shock on Business Cycle and Growth
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| Author | Chen Kunting, Zhou Yan and Huang Jing |
| Organization | College of Economics and Management,Zhejiang University of Technology |
| Email | chenkt@zjut.edu.cn，zhouyan@zjut.edu.cn，huangjing2122@163.com |
| Key Words | Interest Rate Distortion; Financial Shocks; Financial Friction; Cyclical Fluctuation |
| Abstract | We establish a dynamic stochastic general equilibrium business cycle model including two sectors: workers and entrepreneurs. In this model we distinguish the differences in preferences, consumption, savings and propensities to investment among different agents. We divide the interest rates into saving interest rate, loan interest rate and marginal rate of return on capital. We study their equilibrium levels both in short run and in long run, and the interest rates which are implemented in reality. We give out the formation mechanisms of their biases and their effects on cyclical fluctuations. We also study the effects of interest rate distortion shocks on real economics. We find that the negative shock of real saving interest rate leads to the economic growth only within a limited level and in a very short term. In the long run, such a shock leads to a deeper depression and lows the average consumption level of the general workers’ households, but increases the consumption of the entrepreneurs’ households. Financial friction shock affects the growth trend in the long run. We find the crowding-out effect on investment accounts for 81% of one unit demand of financial sector, the crowding-out on the consumption of the general workers’ households accounts for 18%, and the crowding-out on the consumption of entrepreneurs’ households accounts for 1%. Overall, the lasting interest rate distortion enlarges the income gap, and it also increases the wealth disparity through the distortion of income distribution, then affects the potential power of economic growth in the long run. The interest rate distortion affects the long-run economy by two ways: the direct crowding-out effect on investment and the indirect effect on income distribution. |
| Serial Number | WP833 |
| Time | 2015-03-10 |
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