Potential employers want to see an increase in responsibility and progression to more prestigious job titles as they peruse your resume, not the opposite. It's true that a demotion in your work history makes interviews more difficult, especially if you're aiming for a job title similar to the one you had before your responsibilities were downgraded. However, having a demotion on your resume isn't the end of the world. If you explain the reasons for the demotion honestly and intelligently, you can still count yourself in the running for that dream job.
Ask your former boss for a positive reference if possible. Before heading to your job interview, speak with him about the reasons for the demotion and develop a positive explanation that you can both agree on. Don't ask for a reference if your relationship with your boss is strained or if he would be upset about you looking elsewhere for work.
Focus on what you enjoy about your demoted position if the move was voluntary and similar to the new job you want. For example, if you were demoted from a sales manager to a sales associate position and you're applying to a customer service job, you could say that you missed developing new relationships with customers when you moved into management. In this situation, your commitment to front-line customer interaction could help you land the position.
Highlight the circumstances that were beyond your control if the demotion was due to company or department restructuring. For example, perhaps the marketing departments of your company and another organization merged, and the marketing manager from the other company got to keep her role while your title was downgraded. You could say something like: "Unfortunately, there was only room in the budget for one marketing manager, and the other candidate brought more experience to the table. However, the organization chose to keep me on board because I brought so much value to the department."
Explain the reason for the demotion honestly if the change was due to lack of skill, but end your answer on a positive note by saying how you've improved since your position was downgraded. Avoid badmouthing former managers and colleagues. Instead, take full responsibility for your behavior. For example: "I was demoted because my boss didn't feel that my leadership skills were strong enough to run a larger department. He was right, and I was having difficulty at the time. Since then, I've developed my leadership abilities gradually by presiding over smaller project teams. I also signed up as a member of Toastmasters, so now I feel much more confident leading larger groups."
Outline any personal factors that played a role in your demotion. If you were depressed or experiencing family problems at the time, it's acceptable to say so. Just make sure you let the recruiter know that your situation has improved.
Offer your boss' reference to the interviewer after providing your explanation: "I can understand why my demotion might make you feel nervous, so here's the contact information for my boss at the time. I hope that talking with her will help you dismiss any doubts."