The Circular Relationship Between Productivity Growth and Real Interest Rates
39 Pages Posted: 24 Oct 2019
Date Written: October 2019
In most advanced economies, both real interest rates and productivity growth have decreased since the early 1990s. In this paper, we explore the mechanism whereby a circular relationship links these two quantities. While productivity is a key driver of potential output which affects the level of interest rates, the level of interest rates is a determinant of the expected return from investment projects, and thus of the productivity level required for investment. In our model, absent of a technology shock, this specific relationship can only converge to an equilibrium where growth and interest rates are both low. We test this using macroeconomic data on 17 OECD countries and simulate the effect of a temporary productivity shock.
Keywords: Productivity, Slowdown, Secular Stagnation, Interest Rates
JEL Classification: O43, O47, O57, E43
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