Relationship between population and inflation

relationship between population and inflation

Keywords: Demographic Changes, Population Aging, Inflation, Should our models account for any association between ageing and the level of inflation?. relationship between inflation and long-run growth is linear; non-linear; casual or (gy) was driven by population growth (gL), investment (gK) and land growth. relationship between inflation and long-run growth is linear; non-linear; casual or (gy) was driven by population growth (gL), investment (gK) and land growth.

A shrinking population presents a whole new set of challenges, both for the economy and for investors. This type of demographic change translates primarily into falling interest rates over the long term, so we could see a race to zero interest rates.

Obviously, this is not a race anyone wants to win. Very low interest rates are good for people who borrow money, but they create a more difficult environment for investors seeking good returns. In a world where inflation is practically nonexistent and where an aging population is increasingly concerned with saving for retirement, nominal rates of return will remain very low.

The nominal return on an investment is expressed in constant dollars and does not take inflation into account. If you do a supply-side decomposition of the gross domestic product GDPin terms of population, labour force, and productivity, you find a very strong causal relationship between labour force and nominal GDP in constant, non-inflation-adjusted dollars.

Strong labour force growth translates into buoyant GDP growth and, conversely, a shrinking labour force results in GDP contraction. A study on prices in Europe over the past years shows that each period of inflation was preceded, 15 to 20 years earlier, by a rising birth rate.

The Impact of Demographic Trends on Inflation

About 15 to 20 years after this rising birth rate, the labour force would see an influx of young workers starting their careers. This wave of young workers would create strong demand in terms of housing, employment and consumption. With supply barely able to keep up with demand, inflation would ensue. At present, global labour force growth is slowing, and the workforce is composed of an aging population, which suggests a possible shrinking of the labour force because workers will not be replaced.

In a shrinking labour force scenario, demand contracts more quickly than production can be cut back, resulting in a period of deflation marked by extremely low interest rates. Conventional economic wisdom says these two slow-moving trends are unconnected: But our research found a strong link between trend inflation—the average rate at which prices increase over a several-year period—and the age structure of the population.

Specifically, we found that the larger the proportion of young and old in the total population, the higher inflation.

The Impact of Demographic Trends on Inflation | Desjardins Online Brokerage

Put another way, when the working-age population is larger, the effect is disinflationary. This link between age and inflation holds for a large number of countries across all time periods.

These effects are large enough to explain most of trend inflation. For instance, the baby boomers increased inflation by an estimated 6 percentage points in the United States between and and lowered it by 5 percentage points between andwhen they entered working life. Trend inflation is currently low and stable as the decreasing share of young people offsets the effects of the increasing share of old people in the population.

Given that inflation is a monetary phenomenon, why did central banks fail to offset the inflation pressure flowing from the changing age of the population? There are at least two natural explanations. First, political pressure may have impelled central banks to cater to the inflation preferences of dominant age groups. Alternatively, the inflation-age structure pattern could reflect the failure of central banks to anticipate movements in the equilibrium real interest rate—the rate that results in stable inflation.

But neither of these two is a good explanation for what we see in the data. For one, it weakens the argument that expectations play a major role in inflation formation, a thesis that arose from the inflationary experience of the s and s.

Furthermore, the relationship between age structure and the rate of price increases does permit prediction of underlying trend inflation. Our estimates suggest that unless baby boomers work much longer than their parents did, their retirement will ultimately be inflationary.

Exploring inflation trends Inflation puzzles have prompted economic insights in the past. For example, when inflation began to increase in the s without a justifying change in activity, economists searching for an explanation postulated that expectations play a role in inflation formation. Thus, a lasting monetary expansion would generate higher inflation but no lasting output gains. Overly lax monetary policy seemed to explain the increase in inflation, a view that was reaffirmed in the s, when inflation began to fall after central banks started to combat it.

But inflation puzzles have a way of reappearing. Following the global financial crisis that began ininflation did not pick up when economies started to recover. This low inflation is one reason central banks held down rates in the first half of that decade. But it also suggests that something other than monetary policy was in the background suppressing inflation. The prolonged episode of low inflation came when populations in most advanced economies were getting older and baby boomers were in their peak earning periods.

Age groups differ with respect to their consumption-saving decisions, which can affect long-run inflation pressure.

relationship between population and inflation

For instance, people tend to borrow when they are young or their parents do it on their behalfsave during their working life, and live off accumulated assets when they are old.

It follows that inflation pressure is high when the share of young and old people who consume but largely do not produce is large compared with the working-age population which produces more than it consumes and vice versa. But conventional analysis suggests that central banks could, in principle, offset such pressure by raising or lowering interest rates. In such a scenario, aging would affect the real after-inflation equilibrium interest rate, but not inflation.

relationship between population and inflation

Some veteran central bankers have recently proposed why aging might matter for inflation—because of its effect on the conduct of monetary policy. Bullard says that the young, who are borrowers, prefer more inflation because it reduces the real burden of their debt, whereas the old prefer less inflation to preserve the value of their assets.

An alternative view is put forth by Goodhart, Pradhan, and Pardeshiwho suggest that the age structure can change the equilibrium real interest rate.

If central banks ignore such changes, inflation can ensue. The link We estimated the effects of the entire age structure—not just aging—on inflation, using data from 22 advanced economies between andand found a robust relationship between inflation and the age structure.