FINITE HORIZONS, INFINITE HORIZONS, and THE REAL INTEREST RATE

Using an overlapping-generations model in which households may have either finite or infinite horizons, I derive the implications of each horizon for the steady-state real interest rate. I then formulate an econometric model of the steady-state real interest rate and devise tests that can distinguish between finite and infinite horizons. These tests are applied to annual and quarterly U.S. data, which span the period 1875–1988. The results are inconsistent with finite horizons, and broadly consistent with infinite horizons.