The starting point for today’s considerations is the observed high inflation, the trend reversal in the key interest rates of all central banks over the past year, and the resulting increase in nominal current yields on 10-year government bonds with negative real yields at the same time. The key question I will address today is how real interest rates may develop in the long run, from which we can infer nominal interest rates once the current high inflation phase is over (although there is, of course, a great deal of uncertainty in this respect).
For this purpose, I will use a macroeconomic simulation model, which, in the interaction of firms, households and the government sector makes statements about long-term developments, especially of per capita income as well as of interest rates. Regarding the inflation forecast, I will use a crystal ball view rather than a mathematically sound model. An optimistic – or perhaps realistic – forecast by CES-Ifo is a 2.4% inflation rate in 2024. I will assume here that the Fisher decomposition holds, i.e., that the real interest rate clears the capital market, and the inflation rate can then be added on to get the nominal interest rate. I will neglect interactions between the two objects.
The core mechanism is that capital productivity is depressed in an aging population. The reason is that capital relative to labor will be an abundant factor in an aging society. Thus, each unit of installed capital used for production of aggregate output will have a lower marginal productivity, which depresses its return. A trend reversal can occur when dissaving in an aging population more than compensates for the effects of the relative scarcity of labor, which would reduce capital formation. The macroeconomic model employed today will feature this counteracting force. Many things remain (still) unconsidered, such as the role of foreign countries and yield spreads – both of which had great weight in my earlier work – as well as the question of whether increased risk in both labor and capital income leads to an increased investment decision in fixed-income assets and thus depresses the interest rate level. Furthermore, government debt dynamics and their effects on interest rate levels (and vice versa) are not addressed.
As a central result, the model I use shows a good fit to the trajectories of real interest rates since the 1980s. The quantitative evaluation – I prefer the term quantitative evaluation, which is more tentative than, say, the term forecast – shows low/negative real interest rates until around 2030 and then a trend reversal and a corresponding decline in the growth rate of per capita income until 2030. An important note beforehand: I neglect the time-shifted aging dynamics in other countries (the OECD is on average younger than Germany, thus aging later; the same applies to China). Taking these into account, the trend reversal in real interest rates would probably be less pronounced (see the earlier papers Börsch-Supan, Ludwig, and Winter 2006; Krueger and Ludwig 2007).
In what follows, I will first show some facts about inflation and discuss the main literature that sheds light on a link between inflation and demographics. I will then present the results of updated demographic projections for Germany and explain the core elements of the macroeconomic model. When turning to the main results, I focus exclusively on growth rates and interest rates, before finally summarizing the key messages again.
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