Revisiting the Interest Rate Puzzle

This article makes a connection between Lucas' (1978) asset pricing model and the macroeconomic dynamics for some selected countries. Both the relative risk aversion and the impatience for postponing consumption by synthesizing the investor behaviour can help to understand some key macroeconomic issues across countries, such as the savings decision and the real interest rate.We find that the government consumption makes worse the so-called ‘equity premium-interest rate puzzle.' The first root of the quadratic function for explaining the real interest rate can produce this puzzle, but not the second root. Thus, Mehra and Prescott (1985) identified only one possible solution