Uncovering the Relationship between Real Interest Rates and Economic Growth

22 Pages Posted: 7 Feb 2014 Last revised: 18 Feb 2014

See all articles by Bruce Hansen

Bruce Hansen

University of Wisconsin - Madison - Department of Economics

Ananth Seshadri

University of Wisconsin - Madison - Department of Economics

Date Written: December 18, 2013

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 rates 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.

Keywords: economic growth, interest rates, Social Security

Suggested Citation

Hansen, Bruce and Seshadri, Ananth, Uncovering the Relationship between Real Interest Rates and Economic Growth (December 18, 2013). Michigan Retirement Research Center Research Paper No. 2013-303, Available at SSRN: https://ssrn.com/abstract=2391449 or http://dx.doi.org/10.2139/ssrn.2391449

Bruce Hansen

University of Wisconsin - Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States

Ananth Seshadri (Contact Author)

University of Wisconsin - Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States
608-262-6196 (Phone)
608-263-3876 (Fax)

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