Technical documentation section A : the low interest rate environment and structural changes in the real economy : November 2016

The current environment is characterised by exceptionally low nominal interest rates in the European Union (EU), which have reached their lowest level in five decades. The decline started in the mid-1980s, when disinflation began, and then accelerated with the outbreak of the global financial and sovereign debt crises. The decline in market rates has brought about a fall in the financing costs of banks, non-financial corporations, households and governments. Other advanced economies have also experienced declining interest rates. The issue of a low interest rate environment has been gradually attracting the attention of academics and policymakers around the world. There are two main views as to what has driven real interest rates in recent decades. According to the "secular stagnation" explanation, interest rates have declined permanently for structural reasons related to total factor productivity, demographic trends, income and wealth inequality and a preference for scarce safe assets. All these factors have led to the supply of funds (i.e. savings) exceeding demand (i.e. investment). Demographic factors normally form part of an analysis of the level of real interest rates. Lower fertility and rising longevity require more savings for old age, which are marginally offset by a potentially higher retirement age, and can lead to lower aggregate consumption. Population dynamics can also have a dampening effect on investment, as lower population growth requires lower investment to maintain a given capital-to-labour ratio. Slower technological progress and productivity growth implies lower real interest rates. According to the "financial cycle" view, real interest rates declined in response to the global financial crisis-induced recession. The financial cycle in the EU is still negative, as deleveraging is still ongoing and is contributing to both lower growth and lower interest rates.