The Long-Term Discount Rate

The authors develop an expression for the long-term discount rate in an economy in which a representative consumer has access to both a risk-free and a risky production technology. Even when the risk-free sector is very small, and with probability one becomes a negligible fraction of the economy in the long run, interest rates are determined differently than in a single-sector economy. As in a single-risky-sector economy, the short rate depends on risk aversion; however, the long rate depends on consumption growth and volatility (i.e., the production possibilities of the economy), but not on the representative investor's risk aversion.