In this paper, an improved phase generated carrier (PGC) demodulation algorithm based on frequency mixing and division difference is proposed. The effects of phase modulation depth variation and light intensity disturbance of the light source on the demodulated phase signal are investigated theoretically and experimentally. Compared to the traditional PGC differential-cross-multiplying (PGC-DCM) and PGC arctangent (PGC-Arctan) demodulation algorithms, the ameliorated demodulation algorithm eliminates the harmonic distortion of the demodulated signal by extracting the carrier modulation depth through frequency mixing. The demodulation error caused by the light intensity disturbance of the light source is suppressed by division difference. The stability of the demodulation system is improved. To verify the algorithm, a PGC demodulation system is built based on a Michelson interferometer. The experimental results show that when the frequency and amplitude of the sensed signal are set to 1 kHz and 0.4 rad, respectively, the signal-to-noise ratio with the proposed algorithm achieves a gain of 35.66 dB over the PGC-Arctan algorithm and 26.26 dB over the PGC-DCM algorithm.