by Lukasz Rachel and Thomas D. Smith
Bank of England
Long-term real interest rates across the world are low, having fallen by about 450 basis points (bps) over the past thirty years. To understand whether low real rates are here to stay, we need to understand what has caused the decline. The co-movement in rates across both advanced and emerging economies suggests a common driver: the global neutral real rate may have fallen. In this paper we attempt to identify which secular trends could have driven such a fall. Although there is huge uncertainty, under plausible assumptions we think we can account for around 400 bps of the 450 bps fall. Our quantitative analysis highlights slowing global growth expectations as one force that may have pushed down on real rates recently, but shifts in saving and investment preferences appear more important in explaining the long-term decline. We think the global saving schedule has shifted out in recent decades due to demographic forces, higher inequality, and, to a lesser extent, the glut of precautionary saving by emerging markets. Meanwhile, desired levels of investment have fallen as a result of the falling relative price of capital, lower public investment, and an increase in the spread between risk-free and actual interest rates. Looking ahead, in the absence of sustained changes in policy, most of these forces look set to persist, and some may even build further. This suggests that the global neutral rate may remain low and perhaps settle at around 1 percent in the medium to long run. If true, this will have widespread implications for policymakers-not least in how to manage the business cycle if monetary policy is frequently constrained by the zero lower bound.
JEL Codes: E02, E10, E20, E40, E50, E60, F00, F41, F42, F47, J11, O30, O40.
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Discussion by Pierre-Olivier Gourinchas