July 16, 2024

What makes interest rates go down?

What makes interest rates go down?

DrThe decline in interest rates in recent decades is largely due to underlying long-term forces such as demographic change, the transition from capital-intensive industrial societies to service-oriented knowledge economies, increasing unequal distribution of income and wealth, and weak growth in productivity and the economy. Monetary policy may have reinforced this trend, but it has largely followed it.

These findings are not controversial in today’s economics. However, there is no consensus on the weighting of the individual factors influencing lower interest rates. In a new paper, economists Atif Mien, Ludwig Straub and Amir Sophie, based on data for the United States, challenge the popular thesis that demographic change has significantly fueled lower interest rates. You can see that income distribution has a much stronger effect.

The demographics argument makes sense: it says that baby-boomers, who are gradually approaching retirement, are saving a lot in the final phase of their working lives in order to prepare for a financially worry-free life in retirement. In a world where knowledge is more important than physical real capital, such high savings are offset by insufficient demand for investments. Thus, a higher supply of savings leads to a lowering of the rate of interest.

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Mian, Straub, and Sophie took a closer look at the salvage behavior of Americans and came to a conclusion that downplays this argument. The saving behavior of the working population is not much different when looking at individual age groups. The demographic argument is based specifically on the fact that older employees save significantly more than younger employees. The data shows something else: differences in propensity to save are much greater in individual age groups between high- and low-income workers than in other age groups.

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