Demographics and Real Interest Rates Across Countries and Over Time

We explore implications of demographic trends for real interest rates across countries and over time in a tractable multicountry model with imperfect capital mobility. We calibrate it to examine how the interaction of international financial integration and both domestic and foreign demographics shapes low-frequency movements in a country’s real rate. In more financially integrated countries, real rates are more sensitive to global developments than to domestic factors. We estimate panel error-correction models relating real rates to various drivers, imposing some structure informed by the model. Empirical results confirm global factors and domestic demographics are robust determinants of real rates. Alternative specifications highlight the importance of accounting for time-varying financial integration and a broad set of real rate drivers. Both model and empirical results suggest demographic trends explain a meaningful share of the global decline in real rates. Given projections, demographics should continue to exert downward pressure on real rates.