Low frequency drivers of the real interest rate: a band spectrum regression approach

This paper presents an empirical analysis of the underlying drivers of the real interest rate in advanced economies over the last 35 years. We adopt a band spectrum regression approach, which allows to study the link between the real interest rate and its determinants only over low frequencies, leaving aside business cycle fluctuations and high frequency noise. Spectral regressions are pooled across countries, allowing for country fixed effects. Our findings indicate that important factors affecting the long-term movements of real interest rates are the evolution of total factor productivity (with a specific role for human capital accumulation) and demographic trends. Monetary policy developments and changes in income inequality, instead, appear to play a limited part. According to our estimates, over recent years the natural rate of interest fell below zero in the euro area. Finally, the paper provides an empirical contribution to the debate on secular stagnation, suggesting that supply-side mechanisms were one of the most significant factors behind the fall in income growth in the advanced economies over the last two decades.