Abstract
We show that time variation in the discount rate affects investment and employment decisions in a manner consistent with both short and long run Q-theory predictions. Uncovering this novel evidence requires a proxy for the discount rate that reliably predicts stock returns. We gain further insights into the role of the discount rate when we take into account the adjustment costs of investment and employment. The results suggest that firms respond rationally to variations in the cost of capital and that the discount rate affects macroeconomic dynamics.
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