Population Aging and the Real Interest Rate in the Last and Next 50 Years -- A tale told by an Overlapping Generations Model --

Population aging, along with a secular decline in real interest rates, is an empirical regularity observed in developed countries over the last few decades. Under the premise that population aging will deepen further in coming years, some studies predict that real interest rates will continue to be depressed further to a level below zero. In the present paper, we address this issue and explore how changes in demographic structures have affected and will affect real interest rates, using an overlapping generations model calibrated to Japan's economy. We find that the demographic changes over the last 50 years reduced the real interest rate. About 270 out of the 640 basis points decline in real interest rates during this period was attributed to declining labor inputs and higher saving, which themselves stemmed from the lower fertility rate and increased life expectancy. As for the next 50 years, we find that demographic changes alone will not substantially increase or decrease the real interest rate from the current level. These changes reflect the fact that the size of demographic changes in years ahead will be minimal, but that downward pressure arising from the past demographic changes continue to bite in the years ahead. As Japan is not unique in terms of this broad picture of changes in demographic landscapes over the last 50 years and in the next 50 years, our results suggest that, sooner or later, a demography-induced decline in real interest rates may be contained in other developed countries as well.