Low frequency drivers of the real interest rate: Empirical evidence for advanced economies

Abstract

This article presents an empirical analysis of the underlying drivers of the real interest rate in advanced economies since 1980. We adopt a band spectrum regression approach, which allows us to study the link between the real interest rate and its determinants only over low frequencies, leaving aside business cycle fluctuations and high frequency noise.Spectral regressions are pooled across countries, allowing for country fixed effects. Our findings indicate that most of the long-term movements of real interest rates are explained by the evolution of total factor productivity (with a specific role for human capital accumulation) and demographic trends. Monetary policy and credit developments, instead, appear to play a limited part. According to our estimates, over recent years the natural rate of interest has remained positive in the United States and United Kingdom, but fell below zero in the euro area and Japan. Finally, the paper provides an empirical contribution to the debate on secular stagnation, suggesting that supply-side mechanisms were one of the most significant factors behind the fall in income growth in the advanced economies over the last two decades.

Real Interest Rates and Population Growth across Generations*

“…In a similar vein, the effect of a secular decline in population growth on interest rates has received renewed attention amid the current ageing of societies in many parts of the world (see i.e. Ikeda and Saito, 2014;Gagnon et al, 2016;Aksoy et al, 2019;Busetti and Caivano, 2019;Eggertsson et al, 2019a;Eggertsson et al, 2019b;Ferrero et al, 2019;Papetti, 2021). Although population structures within which members of the old generation outnumber members of the young generation are historically unprecedented, they have long been anticipated by the so-called "demographic transition theory", which describes the interrelated trends in birth and mortality rates since the dawn of the modern age (see, e.g., Peston and Bouvier, 2010, pp.271-274;Bloom and Luca, 2016, pp.14ff.).…”

“…Hitherto, this has not been fully recognized by the empirical literature. Many contributions do suggest that the equilibrium rate of interest has recently declined by around one to two percentage points due to demographic factors alone (Ikeda and Saito, 2014;Carvalho et al, 2016;Favero et al, 2016;Gagnon et al, 2016;Aksoy et al, 2019;Busetti and Caivano, 2019;Ferrero et al, 2019;Bielecki et al, 2020;Papetti, 2021). However, all these calibrations and estimations have analyzed the effect of ageing during the last couple of decades and, therefore, account for only a small part of the long-term story told by the relevant OLG models, as well as the demographic transition theory discussed above.…”

The Implications of Globalisation for the ECB Monetary Policy Strategy

“…Most empirical studies have either ignored the global dimension altogether or focused only on how financial globalisation impacts the natural rate. For example, recent contributions have documented a negative relationship between the accumulation of reserves in EMEs and long-run interest rates (Gräb et al, 2019;Busetti and Caivano, 2019) and a positive relationship between the supply of safe assets and global rates (Caballero et al, 2016;Glick, 2020;Ferreira and Shousha, 2020). Less explored empirically is the nexus between changes in trade globalisation and long-run interest rates, with the limited literature finding ambiguous effects (Busetti and Caivano, 2019).…”

“…As a measure of excess savings, we used the current account surplus of seven Asian EMEs, as in Busetti and Caivano (2019). Econometrically, we first tested for the panel co-integration relationship, and then employed estimated error-correction models, using dynamic fixed effects and pooled mean group estimators (Pesaran et al, 1999).…”