Global interest rates can be expected to stay relatively low over the long-term, finds new working paper from the Bank of Canada.

The paper observes that, over the past 15 years, long-term interest rates have declined to levels not seen since the 1970s. In seeking to explain this phenomenon, the authors identify the relative weakness in investment demand as more important than the relative increase in desired global savings to explain the decline in global interest rates.

Moreover, they note that the key factors explaining movements in savings and investment are variables that evolve relatively slowly over time. “These variables include labour force growth, which affects investment demand, and the age structure of the world economy, which has an effect on savings. Other variables such as the level of financial development — reflected in the ability to mobilize savings, to allocate capital, and to facilitate risk management — also affect savings,” it finds. “Since these variables do not fluctuate dramatically, it is unlikely that these key variables will be a source of significant changes in world interest rates over the coming years.”

“That said, in the longer term, the analysis suggests that labour force growth is an important determinant of investment demand. Since labour force growth is likely to continue to fall for some time, one might conclude that this source of downward pressure on interest rates would remain. However, such a conclusion does not take into account that emerging markets are becoming more capital intensive and that labour force growth in these economies remains higher than in most industrialised countries,” it says. “Therefore, emerging markets are likely to become a more important source of investment demand than in the past.”

“These conclusions suggest that over the long term, the world real interest rate is likely to remain low and to continue to adjust slowly, reflecting long-term trends. In the short term, however, the empirical work suggests that unexpected temporary shocks to income, due to fluctuations in oil prices, for example, could lead to significant short-term fluctuations in savings behaviour and real interest rates,” it concludes.