Declining Real Interest Rates: The Role of Energy Prices in Energy Importers

This paper studies whether the upward trend of real energy prices since the 1990s can account for the decreasing trend of real interest rates in energy importers. Using VARs, I first provide empirical evidence that a rise in real energy prices leads to a fall in real interest rate in energy-importing G-7 countries. I then show, using a life-cycle model, that the increasing trend of the real energy price decreases the equilibrium real interest rate by about 1.5 percentage points between 1990 and 2018. Due to increases in the real energy price, energy consumption falls, which dampens consumption of manufactures because of the complementarity between energy and manufactures in consumption. Accordingly, aggregate consumption goes down, which puts downward pressure on the real interest rate. Moreover, the increased real energy price decreases energy inputs in production, and hence capital/energy ratio rises, inducing lower real interest rate via falls in the marginal product of capital. By simulating the model, I also find that increases in the real energy price have more influences on the declining real interest rate in energy importers during 1990-2018 than population aging.