Consider the overlapping generations model where each member lives for two time periods ‘t’ and (t+1). Assume that individuals work in time period ‘t’ and earn wage income, while they do not work in time period (t+1) and survive on interest income. Explain the impact of an increase in interest rate on consumption during time period ‘t’.
If interest rates rise, under the influence of consumption in period t decrease. Indeed, with an increase in interest rates of consumption in period (t + 1) will increase, thereby consumption in period t decrease. This is caused by the lack of income in period (t + 1) at the overlapping generations model.