Examine the properties of an intertemporal consumption choice model under the Fisherian two-period framework. What occurs to current consumption if a consumer is a net lender and the domestic real interest rate increases?

💡 Solution & Explanation

In the Fisherian intertemporal model, a rise in the real interest rate for a net lender generates conflicting income and substitution effects. The substitution effect makes future consumption more expensive relative to present consumption, encouraging individuals to save more and reduce current consumption. Conversely, the higher return on lending increases future wealth, generating a positive income effect that encourages higher consumption in both periods. Therefore, the net impact on current consumption depends on the relative magnitudes of these opposing forces. Irving Fisher detailed this foundational theory of interest and capital.