Europe’s ageing population ‘driving force’ for low interest rates – ECB’s Lane

The ageing demographic across Europe is a “driving force” of low interest rates, according to the European Central Bank’s member of the executive board, Philip Lane.

Addressing attendees of the Annual Investee and Business Leaders’ Dinner, organised by the National Treasury Management Agency in Dublin on Thursday, 28 November, Lane said understanding the root causes of the low level of real interest rates is a “high priority” for monetary and fiscal policymakers, financial-sector participants and the wider populations of savers and investors.

Lane said demographics is one of the driving forces of the current low real interest rates, alongside the determinants of potential growth rates and diverging developments in the returns on risky and safe financial assets.

He noted that over the last 50 years, demographics in advanced economies have been characterised by low fertility rates and rising life expectancy.

Similarly, while in the 1970s and 1980s, the ratio of the elderly (aged 65 and over) to the working-age population (aged 15-64) was around 20 per cent, the European Commission projects the old age dependency ratio will rise to over 50 per cent by the middle of this century, while the ratio of older workers relative to younger workers has trended up significantly over the last decades.

Over the same period, the annual growth rate of the working-age population has fallen from over 1 percent to zero and is projected to turn negative. Lane explained that a number of mechanisms caused by these demographic trends affect the equilibrium interest rate.

“First, the ageing of the population can depress the demand for capital. This in turn is due to the fact that the ratio of installed capital relative to the size of the work force increases as the population ages. Second, ageing can lower productivity growth and thereby reduce investment opportunities. This materialises if the productivity of older age cohorts is lower than that of younger age cohorts.

“Third, in relation to savings rates, if rising life expectancy implies longer retirement periods then individuals and those responsible for publicly provided pensions face incentives to save more. Taken together, a lower level of desired investment and a higher level of desired saving imply a reduction in the natural rate of interest.”

He noted that some experts believe the negative impact of ageing on the equilibrium real rate will be reversed once the largest age cohorts retire and begin dissaving. However, the increase in the capital-labour ratio associated with a sustained phase of higher saving and a contraction in the workforce will weigh on the level of real interest rates for a considerable time, Lane said.

“In terms of magnitude, a wide range of estimates suggest that the downward impact on equilibrium real rates from slowing population growth and rising life expectancy over the period from 1980 to 2050 amounts to about 1 to 2 percentage points in both the United States and the euro area.”

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