What explains the decline in r∗? Rising income inequality versus demographic shifts

Posted on August 28, 2021 by Florian Buschek

Another paper from Atif Mian, Ludwig Straub and Amir Sufi. I have referenced a prior paper “Indebted Demand” before with “A key insight is that growing inequality lowers interest rates and increases household debt“.

In this new paper they argue that inequality is also the reason for secular down trend in interest rates. This not only goes against the popular narrative that central banks depress interest rates but they also show that demographic factors are not responsible (Japan often cited as an example). Importantly the casual chain is not

lower interest rates>>higher asset prices>>higher inequality

Instead it is:

higher income inequality >>higher savings rates>>higher asset prices>>lower interest rates

So in a sense you could argue more income redistribution would lead to higher interest rates and per “Indebted Demand” also to higher economic growth rates. Food for thought.

Downward pressure on the natural rate of interest (r∗) is often attributed to an increase in saving. This study uses microeconomic data from the SCF+ to explore the relative importance of demographic shifts versus rising income inequality on the evolution of saving behavior in the United States from 1950 to 2019. The evidence suggests that rising income inequality is the more important factor explaining the decline in r∗. Saving rates are significantly higher for high income households within a given birth cohort relative to middle and low income households in the same birth cohort, and there has been a large rise in income shares for high income households since the 1980s. The result has been a large rise in saving by high income earners since the 1980s, which is the exact same time period during which r ∗ has fallen. Differences in saving rates across the working age distribution are smaller, and there has not been a consistent monotonic shift in income toward any given age group. Both findings challenge the view that demographic shifts due to the aging of the baby boom generation explain the decline in r∗.

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