The Role of the Discount Rate in Investment and Employment Decisions

Time variation in the discount rate affects investment and employment decisions in a manner consistent with Q-theory predictions. This evidence is uncovered when using cyclical consumption as proxy for the discount rate. The results, which are consistent across both U.S. and international data, suggest that firms respond rationally to variations in the cost of capital and that the discount rate has a substantial impact on macroeconomic dynamics and hence business cycle fluctuations