Do Aging Populations Impact Inflation and Interest Rates?
Recently, there has been a lot of focus on China’s declining population, with India overtaking it as the world’s most populous country. But the bigger and perhaps more urgent issue is that populations are aging, a trend seen across the globe. Economists are trying to figure out how this will affect inflation, and the jury’s still out.
The pace of population aging is much faster than in the past. In 2020, the number of people over 60 years of age worldwide outnumbered children younger than five. Between 2015 and 2050, the proportion of the world's population over 60 will nearly double from 12% to 22%, according to the World Health Organization.
And it’s happening at varying rates. By 2050, South Korea is set to have nine seniors for every working-age person, while South Africa will have two, the World Economic Forum predicts. Among the fastest aging are Eastern European countries (Poland, Slovakia and Slovenia in particular), China and Brazil, while Japan already has the world’s oldest population with 28% over 65 years of age.
The massive labor supply from some of these countries in the past few decades has played a part in low wages and, therefore, low inflation.
“The previous trend lower in interest rates and inflation occurred because demographics lined up over the past 25 years to keep wages low and savings high,” says Bruce Liegel, former fund manager at Millennium and author of Global Macro Playbook, a monthly research series.
“These disinflationary forces allowed global central banks to run very accommodative interest rate policies without any concern that they would be causing a mistake, a.k.a. inflation.”
Some believe that as this supply of workers dwindles, the knock-on effect could be upwards pressure on both prices and already-high inflation, impacting central banks’ interest rate paths.
“This great demographic reversal will lead to a return of inflation, higher nominal interest rates, lessening inequality and higher productivity, but worsening fiscal problems, as medical, care and pension expenditures all increase in our aging societies,” says Charles Goodhart, Emeritus Professor of Banking and Finances at the London School of Economics and co-author of a book on the combined impact of aging societies and a retreat from globalization.
“We doubt that politicians, facing rising health and pension costs, will be prepared or able to raise taxes enough to equilibrate the economy via fiscal policy.”
This school of thought sees the days of zero interest rate policies as gone, with low interest rates unlikely again in the short to medium term, and aging populations limiting the options for central bank rate setters.
Earlier this year, as the UK faced its highest inflation for decades, prompting a series of rate hikes, Bank of England Governor Andrew Bailey warned that early retirement and the resulting shrinking workforce were contributing to pushing prices and interest rates higher.
Others point to Japan as a microcosm of the world’s aging demographics – a ‘test kitchen for “shrinkonomics”’ as the International Monetary Fund puts it – where a rapidly aging population has not notably pushed up inflation. In fact, an IMF study found substantial deflationary pressures there from aging.
Elsewhere, a Federal Reserve study predicts that real interest rates in the US will remain low in the coming decades despite shifting demographics, with the country having reached “a new normal”, while research in the euro area found that although lowered savings among the elderly put upward pressure on interest rates there were several mitigating factors to offset this.
So, one thing’s for sure, the debate looks set to continue, as central banks, governments and economists grapple with rapidly changing demographics and what they may mean for us all.
Further readings on inflation:
The End of Cheap Labor – the Demographic Dilemma
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