Abstract
We solve a version of the analytical Real Business Cycle (RBC) model with a predetermined rate of return on household saving. The solution differs from that of the benchmark RBC model along two dimensions: (i) Policy functions depend on the variance of the technology shock. (ii) There is a suboptimal pattern of excess saving. We discuss the economic intuition underlying these properties. We also demonstrate that unconditional welfare can be higher in the suboptimal model with predetermined interest rates, providing a clear illustration of the pitfall with unconditional welfare comparisons.
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