Question

20. Evaluate and discuss the following statement. “Provided agents can freely borrow/lend with one another, the distribution of endowments (conditional on the aggregate endowments) is irrelevant for the equilibrium real interest.”

Answer 1

The equilibrium real interest rate is a crucial concept in new Keynesian class of models. this rate represents the real rate of return required to keep the economy is output equal to the potential output which in turn is the level of output consistent with flexible prices and wages and constant markups in good and labour markets. .....

It basically reflects the rate of time preference for current goods over the future goods.

When people with wealth can borrow substantial amounts, they often lend the money to the less wealthy people. people can rearrange the timings of The spending by borrowing , lending investing and savings. While mutual gains for both borrowers and lenders motivate credit market transactions, there is a conflict of interest rate between them over the rate of interest, the prudent use of loaned funds and the repayment of loans.

Suppose there are two agents 1 and 2. Both have identical preferences.

The situations where agents are free to borrow and lend, and in particular given aggregate endoweements , the equilibrium rate does not depend on distribution across agents, it only depends upon the aggregate endowments.