Demographics and Real Interest Rate in the US economy

Orientador(a): Carlos Viana de Carvalho

I develop an overlapping generations model with life cycle wage profile (LCWP), age-dependent mortality rate, liquidity constraints, and nominal rigidities. The model is calibrated to capture US demographic transition, LCWP estimations, and other salient features of the US economy during 1950-2017. The model is then used to examine the relationship between demographics and real interest rates and the main transmission mechanisms in play. I find that the rapid increase in the working age population from 1950-1980s has significantly contributed to the rise of real interest rates. The reversion of this process together with the increase in life expectancy triggered a rapid decline in the interest rates ever since. The heterogeneity in the marginal propensity to consume among workers plays a major role in connecting these fertility and real interest rate movements.

In an additional exercise, due to the evidence on large life expectancy forecast errors, I introduce a learning process about longevity and find that it can significantly augment the relevance of demographic factors in explaining real interest rate movements. Finally, I find that the central banks’ failure to recognize the relationship between demographics and interest rates can generate, due to unaccounted changes in the natural interest rate, inflation rate variations.