Population ageing: what is the effect on inflation?

Thursday 14 June 2018

Expert updates

Population ageing: what is the effect on inflation?

Everyone knows that populations are ageing in advanced economies. But the economic consequences of this phenomenon remain unclear. In particular, the impact on inflation is still a subject of debate. The example of Japan, the developed country whose population has aged the most and where inflation has been persistently weak for three decades, has prompted speculation that an ageing population is deflationary. Yet things are not that simple.

There is no economic theory that has explicitly formalised a relationship between demographics and inflation. Demographic change nevertheless affects the labour market’s structure directly, as well as the working population’s size, and, indirectly, people’s behaviour regarding savings. There are several ways in which demographics can theoretically influence inflation:

- Greater longevity should put downward pressure on the natural rate of interest (real equilibrium interest rate) as workers save more in anticipation of a longer retirement (see, for example, Demographics and Real Interest Rates: Inspecting the Mechanism, 2016, working paper of the Fed of San Francisco)

- An increase in the dependent share of a population (those too young or old to work) should bring down the savings ratio and therefore help push up the natural rate of interest. Those at a working age save more than the elderly and youngsters do. Pensioners make purchases by drawing on savings built up over their careers.

- Preferences for certain inflation levels also vary depending on age. Youngsters are generally in debt, so can prefer stronger inflation. In contrast, the elderly use up more of their income, so prefer weaker inflation.

The most comprehensive empirical research into the relationship between the demographic structure of the population and inflation was carried out by Mikael Juselius of the Bank of Finland and Elod Takats of the Bank for International Settlements (The enduring link between demography and inflation, 2018, working paper of the Bank for International Settlements). The two researchers studied 22 countries over a very long period (1870-2016), during which the different countries experienced distinct demographic cycles. The study is different to previous ones in this field, which had only focused on the post-war period. For each country, they followed changes in the share of 17 age groups within the overall population : the 0-4 years group, the 5-9 years group, the 10-14 years group, up to the 75-79 years group and the group over 80 years. The authors then looked at the impact of the population structure on inflation by controlling a certain number of economic variables such as output gap, real interest rates, money aggregates and public debt. Mikael Juselius and Elod Takats reached the conclusion that an increase in the dependent portion of the population (those too young or old to work) is associated with higher inflation while an increase in the share of the working-age population is associated with weaker inflation. Still, the authors point out that the share of the population aged over 80 years has a very negative effect on inflation.