Understanding the New Normal: The Role of Demographics

Abstract

Since the Great Recession, the U.S. economy has experienced low real GDP growth and low real interest rates, including for long maturities. We show that these developments were largely predictable by calibrating an overlapping-generation model with a rich demographic structure to observed and projected changes in U.S. population, family composition, life expectancy, and labor market activity. The model accounts for a 1¼-percentage-point decline in both real GDP growth and the equilibrium real interest rate since 1980-essentially all of the permanent declines in those variables according to some estimates. The model also implies that these declines were especially pronounced over the past decade or so because of demographic factors most-directly associated with the postwar baby boom and the passing of the information technology boom. Our results further suggest that real GDP growth and real interest rates will remain low in coming decades, consistent with the U.S. economy having reached a "new normal."

Why so Low for so Long? A Long-Term View of Real Interest Rates

“…Another variant argues that a higher propensity to save in emerging market economies (EMEs), coupled with investors' growing preference for safe assets, has boosted the supply of saving worldwide (Bernanke (2005), Broadbent (2014), Caballero et al (2008)). Most recently, demographic changes have been singled out (Carvalho et al (2016), Gagnon et al (2016), Rachel and Smith (2017)). This strand typically does not consider inflation explicitly and links real interest rates directly to the posited real-sector determinants.…”

Aging, Factor Prices, and Capital Flows

“…Our paper follows the tradition of Auerbach and Kotlikoff (1987) by using a quantitative general equilibrium model populated by overlapping generations, and incorporates life cycle institutions and demographic projections in detail to tease out the implications of aging on capital flows across borders. 2 Our paper is related to the recent 'secular stagnation' papers such as Ikeda and Saito (2014), Gagnon, Johnson, and Lopez-Salido (2016), Carvalho, Ferrero, and Nechio (2016) and Eggertsson, Mehrotra, and Robbins (2017). Most of this research restricts attention to closed economy models and focus on understanding the mechanisms, including demographics, that contribute to the low real interest rates and economic growth in advanced economies.…”

The Rising Cost of Climate Change: Evidence from the Bond Market

“…Importantly, the various economic forces that have lowered the equilibrium real rate appear likely to persist. Demographic forces, for example, are expected to continue to exert downward pressure on real interest rates for many years to come (Gagnon et al, 2021). Furthermore, the global savings glut has proven to be a lasting phenomenon.…”