In a (December 2015) Bank of England Staff Working Paper, Lukasz Rachel and Thomas Smith dissect the global decline in long-term real interest rates over the last thirty years.
A summary of their executive summary:
Market measures of long-term risk-free real interest rates have declined by around 450bps.
Absent signs of overheating this suggests that the global neutral rate fell.
Expected trend growth as well as other factors affecting desired savings and investment determine the neutral rate.
Global growth was fairly steady before the crisis but may (be expected to) fall after the financial crisis. Recently, slower labor supply (demographics) and productivity growth may account for a 100bps decline in the real rate.
Desired savings rose, due to demographics (90bps), higher within country inequality (45bps), and higher savings rates in emerging markets following the Asian crisis (25bps).
Desired investment fell, due to a lower relative price of capital goods (50bps) and less public investment (20bps).
The spread between the return on capital and the risk-free rate rose (70bps).
These trends look likely to persist and the “global neutral real rate may settle at or slightly below 1% over the medium- to long-run”.
Figure 2 [below] provides a glimpse of the relevant pattern by depicting the raw correlation between the change in GDP per capita between 1990 and 2015 and the change in the ratio of the population above 50 to the population between the ages of 20 and 49. … even when we control for initial GDP per capita, initial demographic composition and differential trends by region, there is no evidence of a negative relationship between aging and GDP per capita; on the contrary, the relationship is significantly positive in many specifications.
In his blog, John Cochrane critically reviews arguments in favor of higher inflation in Japan.
He approves of the view that a conventional stimulus argument does not make much sense—given that Japanese growth is around potential and unemployment is low.
He does not approve of the view that inflation would be helpful by lowering (public and private) debt burdens. He doubts that an inflation induced default on outstanding debt would significantly lower taxes (rather than lead to more government spending) and that even if it did, such a default would increase the optimism of young households.
He also questions whether inflation could significantly reduce the real value of Japanese public debt (because debt maturity is short) and whether the debt burden is actually large (given near zero interest rates).
A report by the White House Council of Economic Advisors surveys long-term interest rates. The “key takeaways” include:
Real and nominal interest rates in the United States have been on a steady decline since the mid-1980s. Declining interest rates are a global phenomenon. … [F]orecasters largely missed the secular decline of the last three decades.
The Ramsey growth model implies a link between labor productivity growth, per capita consumption growth and the real (inflation-adjusted) interest rate. Historically, periods of low real long-term interest rates have tended to coincide with low labor productivity growth. Projections of labor productivity growth, while imprecise, suggest 10-year real interest rates in the range of 1.5 to 3.5 per cent.
Asset-pricing models that incorporate risk suggest that the long-run nominal interest rate is the sum of expected future short-term real rates, expected future inflation rates, and a term premium. The 10-year rate in ten years that forward transactions in nominal Treasuries imply is currently 3.1 percent. Forward transactions in the market for TIPS suggest a long-term real rate just above 1.00 percent in ten years. Adding the CPI inflation rate implied by the Federal Reserve’s PCE inflation target would imply a forward nominal interest rate of 3.25 percent. The term premium in nominal Treasuries is currently estimated to be near zero, with a 2005-2014 mean of 1 percent. These components together suggest a 10-year nominal interest rate in the range of 3.1 (forward Treasuries) to 4.6 percent (based on FOMC forecasts of the long-run federal funds rate).
In a world with financially integrated national capital markets, the general level of world interest rates is determined by the equality of the global supply of saving and global investment demand. Capital markets of advanced economies are now tightly integrated while emerging market economies are becoming increasingly integrated into the global financial system. Low-income economies remain partially segmented from the global capital market. As a consequence of increasing international market integration, long-term real and nominal interest rates are increasingly moving in tandem and have declined along with U.S. rates. Nominal interest rates also tend to be correlated across countries though differences in inflation expectations can produce differences in nominal rates. In a world with uncertainty, global long-term real and nominal interest rates will include risk premiums that can reflect country-specific risk factors. Strong economic linkages, however, reinforce substantial correlation in countries’ long-term bond risk premiums.
Long-term interest rates are lower now than they were thirty years ago, reflecting an outward shift in the global supply curve of saving relative to global investment demand. It remains an open question whether the underlying factors producing current low rates are transitory, or imply long-run equilibrium long-term interest rates lower than before the financial crisis. Factors that are likely to dissipate over time—and therefore could lead to higher rates in the future—include current fiscal, monetary, and exchange rate policies; low-inflation risk as reflected in the term premium; and private-sector deleveraging in the aftermath of the global financial crisis. Factors that are more likely to persist—suggesting that low interest rates could be a long-run phenomenon—include lower forecasts of global output and productivity growth, demographic shifts, global demand for safe assets outstripping supply, and the impact of tail risks and fundamental uncertainty.