Uncovering the Relationship between Real Interest Rates and Economic Growth

Authors

Abstract

We analyze long-span data on real interest rates and productivity growth with the focus on estimating their long-run correlation. The evidence points to a moderately negative correlation, meaning that real interest ratesĀ are mildly countercyclical, although the estimates are not precise. Our best estimate of the long-run correlation is -0.20. The implications for long-term projections are as follows. A negative correlation implies that long-run costs due to a period of low interest rates will tend to be slightly offset by a period of high productivity growth. Conversely, long-run benefits during a period of high interest rates will be offset by low productivity growth. This implication is consistent with the question raised in the project solicitation concerning why the trust fund stochastic simulations tend to show less long-run variability than do the alternative assumption projections. We also examine the implications for the variability of long-term projections of trust fund accumulation. As expected, we find that a negative correlation reduces the variability in the stochastic intervals. However, our simplified calculations suggest that the effect is modest.

Key Findings

  • There is little theoretical or empirical guidance on the long-run relationship between real interest rates and economic growth.
  • Real interest rates and economic growth have an estimated long-run correlation of -0.2.
  • This mild negative correlation suggests that the variability in interest rates and growth slightly offset one another.

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Project

Paper ID

WP 2013-303

Publication Type

Working Paper

Publication Year

2013
pavement-enterprise