## 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016

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### Introduction and central hypothesis
- Coverage period: 1985–2016.
- Observed facts:
  - Global real interest rates (short- and long-term) showed large variation: low and flat in the 1960s, declining in the first half of the 1970s, rising strongly to a mid-1980s peak, and trending down since then.
  - Real rates have tightly co-moved across regions, suggesting common structural drivers.
- Central hypothesis:
  - Globalization (integration of goods and labor markets) altered firms’ and workers’ markups, generating a time-varying “globalization premium” that affected the natural real interest rate.

### Mechanism: globalization → markups → natural real interest rate
- Definitions preserved:
  - Total gross markup = price markup × wage markup (gross markups).
  - “Globalization premium”: component of the natural rate associated with expectations of increased competition (falling equilibrium markups).
  - Natural real interest rate: rate consistent with output at potential and constant inflation.
- Mechanism summary:
  - Declining markups (greater competition) act like increases in productivity: they raise expected future income, inducing households to postpone consumption and thereby increasing the natural real interest rate.
  - Because markups are bounded below by perfect competition, the globalization-induced rise in the natural rate is transitory: as globalization matures, the globalization premium fades and natural rates revert toward lower levels.

### Simple neo-classical model — analytical results
- Flexible-price equilibrium linkage:
  - Natural real interest rate depends on the patience parameter ߩ (beta, ߚ), expected productivity growth (݃), and expected growth in total (gross) markups (Φ).
- Key analytical properties (as presented):
  - Equation (8): natural real rate depends negatively on ߚ and positively on expected productivity growth and the expected pace of markup decline (globalization premium).
  - Equations (11) and (13): globalization premium ܲܩܛݎ is a non-linear, time-varying term that tends to 0 as total markups converge to their long-term level ࣧ (perfect-competition limit ࣧ=1 in examples).
- Non-linearity:
  - Because total markups are bounded below, the globalization premium first raises natural rates as globalization accelerates, then erodes as markups approach their bound.

### Magnitudes and illustrative calibrations
- Initial calibration facts:
  - Initial (net) total markup example: 60 percent (gross markup ࣧ =1.6).
  - Half-life concept: half-life ݄ is number of periods to halve the distance between initial markups and long-term value.
- Example calibrations and outcomes:
  - Half-life 25 years (ࣧ௧௢௧௔௟,ఛାଶହ ≈1.3) with initial gross markup 1.6 yields a globalization premium of about one percentage point of the natural real interest rate.
  - Faster globalization (half-life 15 years) produces a larger initial globalization premium (example: 1.7 pp versus 1.0 pp in the 25-year half-life case).
- Additional parameter values:
  - Half-life alternatives discussed: 25 years, 15 years, and 50 years (non-traded sector).
  - Initial markups in the large model calibration (1980): goods sectors 40 percent + labor market 20 percent = 60 percent total.
  - GIMF simulation peak: real interest rates peak in the second half of the 1980s around 0.9 pp above their initial steady-state.

### Empirical evidence (time series regression)
- Data and proxies:
  - Annual sample: 1985–2016 (31 annual observations).
  - Global import penetration (World Bank) used as proxy for exposure to international competition; markups proxied by inverse of global import penetration.
  - Global real interest rates (short 1 year and long 10 years) from IMF; global multifactor productivity growth: weighted average of annual TFP growth in the G20 (OECD Statistics).
- Empirical specification:
  - Long-term real rate modeled as function of (i) expected productivity growth Ω and (ii) function of current markups Ϝ (globalization premium function), plus constant (equation (14) and simplified (15)).
  - Two expectation cases estimated:
    - Perfect foresight (PF) with ܶ=1 (ST).
    - Naive backward-looking (BL) with ܶ=10 (LT) where three-year average TFP growth is used for expectations.
- Key regression findings (selected estimates reported exactly):
  - PF ST: mu = -27.32, alpha = 38.18, beta = 0.00, gamma1 = 0.59, R-squared (adjusted) = 0.83, DW = 1.81 (t-stats in parentheses: (-5.29) (4.91) 0.00 (3.68))
  - PF LT: mu = -25.46, alpha = 37.70, beta = -0.66, --, R-squared (adjusted) = 0.84, DW = 2.14 (t-stats: (-8.23) (8.06) (-0.51))
  - BL ST: mu = -22.06, alpha = 29.35, beta = 2.61, gamma1 = 0.93, R-squared (adjusted) = 0.86, DW = 2.15 (t-stats: (-5.32) (5.59) (3.91) (8.66))
  - BL LT: mu = -21.70, alpha = 31.88, beta = 0.54, --, R-squared (adjusted) = 0.82, DW = 2.36 (t-stats: (-7.44) (7.62) (0.77))
- Diagnostic tests:
  - Engle-Granger cointegration test (1985–2016): p-values for null of no cointegration (with trend) of tau- and z-statistic are 0.0051 and 0.0000 respectively.
  - Phillips-Ouliaris test p-values: 0.0011 and 0.0262 respectively.
- Empirical interpretation:
  - Globalization proxy (import penetration / inverse-markup measure) is an important explanatory variable for the equilibrium real interest rate; TFP growth is not significant when globalization is included.
  - Caveat: short sample (31 observations) limits precision; VECM yields similar conclusions that globalization proxy dominates TFP growth (insignificant).

### Multi-region GIMF simulations and robustness
- Model description:
  - Global Integrated Monetary and Fiscal Model (GIMF), 3-region (US, euro area, rest of world), micro-founded, OLG with liquidity-constrained (LIQ) households.
- Calibration specifics:
  - Starting (net) markups in 1980: goods 40 percent, labor 20 percent → total 60 percent.
  - Markups decline at pace corresponding to half-life of 25 years in traded sectors; non-traded sector half-life of 50 years.
  - LIQ households share: typical assumptions referenced (e.g., 25 percent in advanced economies, 50 percent in emerging markets).
- Simulation outcomes:
  - Short- and long-term real interest rates in the US rise initially as a ‘globalization premium’ emerges and peak in the second half of the 1980s around 0.9 pp above their initial steady-state.
  - Short-term rates display a hump-shaped response due to frictions and monetary policy reaction; long-term rates respond faster due to forward-looking agents.
  - Output rises and inflation falls in response to lower markups, consistent with observed trends (1990–2007: global growth rose while interest rates declined).
  - Simulation results align qualitatively with the simple model: declining markups can explain the initial rise and later persistent decline of real interest rates.

### Policy-relevant implications and conclusions
- Main conclusions:
  - Globalization and the associated change in market power can be a significant driver of global real interest rates via a time-varying globalization premium.
  - The 1980s globalization premium may have been as high as one percentage point per annum in the examples and simulations.
  - As globalization maturated and gains in competition slowed, the globalization premium eroded, providing a partial explanation for the persistent downward trend in real rates since the mid-1980s.
  - If markups were to rise (re-trenchment from globalization or rising market power), growth and natural rates could be pushed further down.
- Implications for future rates:
  - Absent significant changes in expectations about the pace of global integration, long-term real interest rates are unlikely to revert to the higher levels seen during the globalization acceleration phase.
  - A retrenchment from globalization, or a sustained increase in market power, would accentuate declines in the natural real interest rate.

*Source: wpiea2019095 - 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016 — wpiea2019095.pdf*

### 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016 _____________________ 14

### 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016

### Main content
- Title: 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016
- Coverage period: 1985–2016

### Appendix and figures
- Appendix present.
- Figures section indicated with page reference: 17

*Source: wpiea2019095 - 1. OLS Estimates of Fundamental Drivers of Real Interest Rates, 1985–2016 — wpiea2019095.pdf*

### REFERENCES __________________________________________________________________________ 22

### wpiea2019095 - REFERENCES __________________________________________________________________________ 22

### Introduction and central hypothesis
- Over the last five decades global real interest rates (short- and long-term) exhibited large variation: low and flat in the 1960s, declining in the first half of the 1970s, rising strongly to a mid-1980s peak, and trending down since then.
- Real rates have tightly co-moved across regions, suggesting common structural drivers.
- The paper complements the literature on secular drivers of the decline in equilibrium real interest rates by arguing that globalization (integration of goods and labor markets) altered firms’ and workers’ markups, generating a time-varying “globalization premium” that affected the natural real interest rate.

### Mechanism: globalization → markups → natural real interest rate
- Basic intuition:
  - Declining markups (greater competition) act like increases in productivity: they raise expected future income, inducing households to postpone consumption and thereby increasing the natural real interest rate.
  - Because markups are bounded below by perfect competition, the globalization-induced rise in the natural rate is transitory: as globalization matures, the globalization premium fades and natural rates revert toward lower levels.
- Definitions and key terms preserved:
  - Total gross markup = price markup × wage markup (gross markups).
  - “Globalization premium”: component of the natural rate associated with expectations of increased competition (falling equilibrium markups).
  - Natural real interest rate: rate consistent with output at potential and constant inflation.

### Simple neo-classical model — analytical results
- Flexible-price equilibrium yields an expression linking the natural real interest rate to:
  - the patience parameter ߩ (beta, ߚ),
  - expected productivity growth (݃),
  - expected growth in total (gross) markups (Φ).
- Key analytical expressions (as presented):
  - Equation (8): natural real rate depends negatively on ߚ and positively on expected productivity growth and the expected pace of markup decline (globalization premium).
  - Equation (11) and (13): globalization premium ܲܩܛݎ is a non-linear, time-varying term that tends to 0 as total markups converge to their long-term level ࣧ (perfect-competition limit ࣧ=1 in examples).
- Non-linearity: because total markups are bounded below, the globalization premium first raises natural rates as globalization accelerates, then erodes as markups approach their bound.

### Magnitudes and illustrative calibrations
- Calibration examples used in the paper:
  - Initial (net) total markup example: 60 percent (gross markup ࣧ =1.6).
  - Half-life concept: half-life ݄ is number of periods to halve the distance between initial markups and long-term value.
  - Example with half-life 25 years (ࣧ௧௢௧௔௟,ఛାଶହ ≈1.3) and initial gross markup 1.6 yields a globalization premium of about one percentage point of the natural real interest rate.
  - Faster globalization (half-life 15 years) produces a larger initial globalization premium (example: 1.7 pp versus 1.0 pp in the 25-year half-life case).
- Additional parameter values reported:
  - Half-life alternatives discussed: 25 years, 15 years, and 50 years (non-traded sector).
  - Initial markups in the large model calibration (1980): goods sectors 40 percent + labor market 20 percent = 60 percent total.
  - GIMF simulation peak: real interest rates peak in the second half of the 1980s around 0.9 pp above their initial steady-state.

### Empirical evidence (time series regression)
- Data and sample:
  - Annual sample: 1985–2016 (31 annual observations).
  - Global import penetration (World Bank) used as proxy for exposure to international competition; markups proxied by inverse of global import penetration.
  - Global real interest rates (short 1 year and long 10 years) from IMF; global multifactor productivity growth: weighted average of annual TFP growth in the G20 (OECD Statistics).
- Empirical specification:
  - Long-term real rate modeled as function of (i) expected productivity growth Ω and (ii) function of current markups Ϝ (globalization premium function), plus constant (equation (14) and simplified (15)).
  - Two expectation cases estimated: perfect foresight (PF) with ܶ=1 (ST) and naive backward-looking (BL) with ܶ=10 (LT) where three-year average TFP growth is used for expectations.
- Key regression findings (Table 1 summary, as reported):
  - Globalization proxy (import penetration / inverse-markup measure) is an important explanatory variable for the equilibrium real interest rate; TFP growth is not significant when globalization is included.
  - Estimates reported (selected lines extracted exactly as in source Table 1):
    - PF ST: mu = -27.32, alpha = 38.18, beta = 0.00, gamma1 = 0.59, R-squared (adjusted) = 0.83, DW = 1.81 (t-stats in parentheses: (-5.29) (4.91) 0.00 (3.68))
    - PF LT: mu = -25.46, alpha = 37.70, beta = -0.66, --, R-squared (adjusted) = 0.84, DW = 2.14 (t-stats: (-8.23) (8.06) (-0.51))
    - BL ST: mu = -22.06, alpha = 29.35, beta = 2.61, gamma1 = 0.93, R-squared (adjusted) = 0.86, DW = 2.15 (t-stats: (-5.32) (5.59) (3.91) (8.66))
    - BL LT: mu = -21.70, alpha = 31.88, beta = 0.54, --, R-squared (adjusted) = 0.82, DW = 2.36 (t-stats: (-7.44) (7.62) (0.77))
  - Cointegration and residual diagnostics:
    - Engle-Granger cointegration test (1985–2016): p-values for null of no cointegration (with trend) of tau- and z-statistic are 0.0051 and 0.0000 respectively.
    - Phillips-Ouliaris test p-values: 0.0011 and 0.0262 respectively.
  - Caveat: short sample (31 observations) limits precision; VECM yields similar conclusions that globalization proxy dominates TFP growth (insignificant).

### Multi-region GIMF simulations and robustness
- Model: Global Integrated Monetary and Fiscal Model (GIMF), 3-region (US, euro area, rest of world), micro-founded, OLG with liquidity-constrained (LIQ) households.
- Calibration specifics:
  - Starting (net) markups in 1980: goods 40 percent, labor 20 percent → total 60 percent.
  - Markups decline at pace corresponding to half-life of 25 years in traded sectors; non-traded sector half-life of 50 years.
  - LIQ households share: typical assumptions referenced (e.g., 25 percent in advanced economies, 50 percent in emerging markets).
- Simulation results (summarized outcomes):
  - Short- and long-term real interest rates in the US rise initially as a ‘globalization premium’ emerges and peak in the second half of the 1980s around 0.9 pp above their initial steady-state.
  - Short-term rates display a hump-shaped response due to frictions and monetary policy reaction; long-term rates respond faster due to forward-looking agents.
  - Output rises and inflation falls in response to lower markups, consistent with observed trends (1990–2007: global growth rose while interest rates declined).
  - The simulation results are consistent with the simple model’s qualitative predictions and confirm that declining markups can explain the initial rise and later persistent decline of real interest rates.

### Policy-relevant implications and conclusions
- Key conclusions:
  - Globalization and the associated change in market power can be a significant driver of global real interest rates via a time-varying globalization premium.
  - The 1980s globalization premium may have been as high as one percentage point per annum in the examples and simulations.
  - As globalization maturated and gains in competition slowed, the globalization premium eroded, providing a partial explanation for the persistent downward trend in real rates since the mid-1980s.
  - If markups were to rise (re-trenchment from globalization or rising market power), growth and natural rates could be pushed further down.
- Implications for future rates:
  - Absent significant changes in expectations about the pace of global integration, long-term real interest rates are unlikely to revert to the higher levels seen during the globalization acceleration phase.
  - A retrenchment from globalization, or a sustained increase in market power, would accentuate declines in the natural real interest rate.

*Source: wpiea2019095 - REFERENCES __________________________________________________________________________ 22*

### References

### wpiea2019095 - References

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*Source: wpiea2019095 - References*

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_Source: https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019095.pdf_