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The Secular Decline in Real Interest Rates

Paper Session

Friday, Jan. 3, 2020 8:00 AM - 10:00 AM (PDT)

Marriott Marquis, Santa Rosa
Hosted By: American Economic Association
  • Chair: Raghuram Rajan, University of Chicago

On Falling Neutral Real Rates, Fiscal Policy and the Risks of Secular Stagnation

Łukasz Rachel
,
Bank of England
Lawrence Summers
,
Harvard University

Abstract

We demonstrate that neutral real interest rates would have declined by far more than what has been observed in the industrial world but for offsetting fiscal policies over the last generation. Neutral real interest rates are best estimated for the block of all industrial economies given capital mobility between them and relatively limited fluctuations in their collective current account. We show that neutral real interest rates have declined by at least 300 basis points over the last generation. We argue that these secular movements are in larger part a reflection of changes in saving and investment propensities rather than the safety and liquidity properties of Treasury instruments. We then point out that the movements in the neutral real rate reflect both developments in the private sector and in public policy. We highlight the levels of government debt, the extent of pay-as-you-go old age pensions and the insurance value of government health care programs have all ceteris paribus operated to raise neutral real rates. Using estimates drawn from the literature, as well as two general equilibrium models emphasizing respectively lifecycle heterogeneity and idiosyncratic risks, we suggest that the “private sector neutral real rate” may have declined by as much as 700 basis points since the 1970s. Our findings support the idea that, absent offsetting policies, mature industrial economies are prone to secular stagnation. This raises profound questions about stabilization policy going forward. Achievement of levels of deficits and government debt generally considered desirable would likely mean negative neutral real rates in the industrial world. Policymakers going forward will need to engage in some combination of greater tolerance of budget deficits, unconventional monetary policies and structural measures to promote private investment and absorb private saving if full employment is to be maintained and inflation targets are to be hit.

Global Real Rates: A Secular Approach

Pierre-Olivier Gourinchas
,
University of California-Berkeley
Helene Rey
,
London Business School
Maxime Sauzet
,
University of California-Berkeley

Abstract

The current environment is characterized by low real rates and by policy rates close to or at their effective lower bound in all major financial areas. We analyze these unusual economic conditions from a secular perspective using data on aggregate consumption, wealth and asset returns. Our present-value approach decomposes fluctuations in the global consumption-to-wealth ratio over long periods of time and show that this ratio anticipates future movements of the global real rate of interest. Our analysis identifies two historical episodes where the consumption-to-wealth ratio declined rapidly below its historical average: in the late 1920s and again in the mid 2000s. Each episode was followed by a severe global financial crisis and depressed real rates for an extended period of time. Our empirical estimates suggest that the world real rate of interest is likely to remain low or negative for an extended period of time.

Demographics and Real Interest Rates across Countries and over Time

Carlos Carvalho
,
PUC-Rio
Andrea Ferrero
,
University of Oxford
Felipe Mazin
,
University of Pennsylvania
Fernanda Nechio
,
Central Bank of Brazil

Abstract

We explore the implications of demographic trends for the evolution of real interest rates over time and across countries. To that end, we first develop a multicountry, general-equilibrium model with imperfect capital mobility and differential demographic trends. We calibrate a two-country version of the model to study how low-frequency movements in a country's real interest rate depends on its own demographics and on global factors, given its degree of financial integration and its size. The more financially integrated a country is and the smaller its size, the higher the sensitivity of its real interest rate to global developments is, and the less its own real rate determinants matter. Drawing on the lessons from the model, we then estimate panel error-correction models relating real interest rates to possible determinants---including demographics---interacted with measures of countries' degrees of financial integration and size. Our empirical evidence supports a meaningful role for life expectancy in determining real interest rates.

Why So Low for So Long? A Long-Term View of Real Interest Rates

Claudio Borio
,
Bank for International Settlements
Piti Disyatat
,
Bank for International Settlements
John Mikael Juselius
,
Bank of Finland
Phurichai Rungcharoenkitkul
,
Bank for International Settlements

Abstract

Prevailing explanations of the decline in real interest rates since the early 1980s are premised on the notion that real interest rates are driven by variations in desired saving and investment. But based on data stretching back to 1870 for 19 countries, our systematic analysis casts doubt on this view. The link between real interest rates and saving-investment determinants appears tenuous. While it is possible to find some relationships consistent with the theory in some periods, particularly over the last 30 years, they do not survive over the extended sample. This holds both at the national and global level. By contrast, we find evidence that persistent shifts in real interest rates coincide with changes in monetary regimes. Moreover, external influences on countries’ real interest rates appear to reflect idiosyncratic variations in interest rates of countries that dominate global monetary and financial conditions rather than common movements in global saving and investment. All this points to an underrated role of monetary policy in determining real interest rates over long horizons.
Discussant(s)
Benjamin Friedman
,
Harvard University
David Lopez-Salido
,
Federal Reserve Board
Benoit Mojon
,
Bank of International Settlements
James D. Hamilton
,
University of California-San Diego
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • F6 - Economic Impacts of Globalization