Central banks's influence on interest rates greatly diminished

Changing demographics across the globe are the main drivers of low interest rates in many developed countries, according to a new study released Thursday.

The study, entitled Why Are Interest Rates So Low, is conducted by the Fraser Institute, an independent, non-partisan Canadian public policy think-tank.

"Monetary policy is having less and less impact on interest rates in developed economies such as Canada because the demographic relationship between borrowers and savers has changed dramatically," said Michael Walker, author of the study that develops a new model of how interest rates are determined.

For most of the 20th century, there were many more borrowers than savers. Subsequently, interest rates were high to encourage more saving and ration the scarce funds to borrowers.

However, the opposite is true nowadays. There's a dearth of borrowers, so savers are relatively more numerous.

According to the study, the existence of relatively more savers attempting to invest their funds is the main factor affecting interest rates, not monetary policy conducted by the Bank of Canada or the Federal Reserve.

The study compiles financial and demographic data for 29 countries that account for nearly 90 percent of the world's economic output. Walker's new model of how interest rates are determined differs from popular, yet faulty, economic models, which rely on the use of "typical households" to project economy-wide responses to factors thought to influence interest rates.

Relying on these faulty models, many analysts have predicted that interest rates will return to normal levels sometime soon. And central banks have tried to "talk up" interest rates. Meanwhile, rates in most of the major economies continue to be very low.

"The objectives and behavior of 'typical households' in Canada and most of the world is dramatically different today than when these now-faulty models were constructed, so it's no surprise that most private analysts and central banks have incorrect expectations," Walker said. Endit