Why so low for so long? A long-term view of real interest rates

BIS Working Papers No 685
December 2017



We study the reasons for the decline in real (inflation-adjusted) interest rates over the last 30 years. We test the common claim that the decline purely reflects non-monetary factors that drive saving and investment. We also examine the role of monetary policy. This matters because the standard view rules it out.


The analysis is comprehensive. We consider a very long period, 1870-2016, and 19 countries. We examine many popular non-monetary factors: output and productivity growth, several demographic variables, the relative price of capital, inequality and risk. And we explore the role of monetary policy frameworks. The rich sample is necessary to test the hypotheses systematically. It lets us assess whether observed patterns are coincidental or reflect stable relationships.


The standard non-monetary factors do not explain real interest rates well. The patterns seen in the past 30 years appear coincidental. By contrast, monetary policy frameworks seem to play a more significant role. Our findings raise questions about some deeply-held beliefs that underpin macroeconomic analysis and policy.



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.

JEL classification: E32, E40, E44, E50, E52

Keywords: real interest rate, natural interest rate, saving, investment, inflation, monetary policy