Consumption, Production, Inflation and Interest Rates: A Synthesis

By Douglas Breeden
1984| Working Paper No. 677

This paper uses discrete-time and contiuous-time models to derive equilibrium relations among real and nominal interest rates and the expected growth, variance and covariance parameters of optimally chosen paths for aggregate real consumption and aggregate production. Simple, intuitive and fairly general relations are obtained which apply to most of the models of financial economics in the 1970s. The single-good analysis generalizes and provides a synthesis of many prior works. More originally, the paper shows that the positive relation between the interest rate and the expected growth of aggregate real consumption holds in a general multi-good economy, but the negative relation to real consumption variance is ambiguous in general. The relevant inflation rate for the “Fisher” effect is shown to be appropriately measured using goods’ aggregate marginal expenditure shares. Consistent movements in interest rates, inflation and consumption and production aggregates during a business cycle are discussed.