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Demography is Destiny

Low inflation the new normal?

Low inflation the new normal?

by Marcus Roberts | January 10, 2019

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Many countries around the world are facing an ageing population. Some, such as Japan and Eastern Europe, are facing a declining population. Aside from the social implications of a more top-heavy population pyramid in these countries, such a demographic change brings with it economic costs. Most obviously, these costs come from a higher number of elderly people requiring pensions and social security payments (if these exist in a particular country) as well as expensive medical care for age-related diseases. But this article from NewsMax discusses some of the other, less obvious, economic effects that an ageing population can have on a country.

The largest effect will be that an ageing population will tend to lead to slower economic growth and low inflation, perhaps even deflation. This means that interest rates will in all likelihood remain very low for a long period of time. Good news for borrowers and house buyers, but the problem is that an ageing population has fewer of these home buyers and well as fewer car buyers or buyers of other durable goods.

On the other hand, as the workforce shrinks and gets older, this will stimulate more labour-saving and labour-replacing technological innovations and a lift in real wages for those remaining in the working-aged population bracket. This has happened in Japan which has seen productivity increase, even as the population as a whole has shrunk. Interestingly, as the working aged population has shrunk in Japan, the labour force has actually been gradually rising due to an increase in labour force participation as women have entered the workforce in greater numbers. Although this has softened the blow of an ageing population, it fuels the demographic ageing that it is designed to combat: as more women enter the workforce, they delay marriage and childbearing and thus continue to suppress the number of children (and future workers) being born. All of these factors largely explain why Japan’s inflation rate remains near zero despite ultra-relaxed monetary policy of the Bank of Japan. A similar, albeit less extreme version of these trends can be seen in China also where the effects of the ill-begotten one child policy will be felt for a long time.

Although the USA has a much higher fertility rate than China and Japan, its trajectory is still downwards. Young people are staying single for longer and are likely to have fewer children than in previous generations. The number of live births in the USA in the year to March 2018 was the lowest since 1997 and represents the lowest natural growth (births minus deaths) since December 1972. Ageing baby boomers are downsizing and the young generation are not necessarily taking up the consumer slack. This means that inflation and interest rates should remain subdued in the foreseeable future.

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