A laser interferometry system was built to accurately realize the frequency identification of low-frequency underwater targets. An improved algorithm was proposed based on the Phase-Generated Carrier (PGC) demodulation technology using the arctangent demodulation algorithm. First, a set of interference experiment systems was built using discrete optical elements under an optical darkroom. Water surface waves were introduced into the reference optical path as a high-frequency carrier, and the interference signal was obtained by interference with the main reflector of measuring and reference light. Next, sine mixing of the carrier signal is introduced based on the arctangent algorithm of the PGC demodulation technique. Using the power comparison algorithm, the group with stronger power was selected between two groups of orthogonal signals for demodulation, so as to avoid demodulation distortion caused by the initial carrier phase. Finally, the anti-interference ability was demonstrated by experiments under substantial mechanical disturbance. Experimental results show that the lower detection limit of the underwater sound source is approximately 30 Hz, and the frequency detection accuracy obtained by multiple detections is better than 1 Hz at frequencies above 100 Hz. The improved arctangent demodulation algorithm can effectively avoid demodulation distortion and has a strong anti-interference ability.