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One of the biggest mysteries of the Japanese economy during the decades of 2010 with ‘Abenomics’ stimulus in the 2010s was why the rapid aging of the population did not increase wages for those of working age. Since almost a third of the population aged 65 or older accepted the theory, pensioners would surely start taking away their assets, first by spending on delicious meals and outings to the golf course, and then finally to pay for care as their health begins to to fail.
These expenses will lead to a demand for the labor of a shrinking group of younger workers. This in turn will increase wages in general, and then these rising wages will cause prices to rise and help the Bank of Japan in its stubborn attempt to reach an inflation target of 2 per cent after years of efforts.
The underlying idea – that the aging population reaches a point where retirement savings exceed greater spending and demand for labor – is central to the argument of economists Charles Goodhart and Manoj Pradhan. They suggest that a demographic turnaround will change the current era of stagnant prices into a new inflationary period.
So far, however, it has not played out that way in Japan. The demand for labor has certainly increased: there are almost four open jobs in Japanese nursing homes for every applicant. But even when the economy was at its strongest in 2018, this demand never changed into higher wages, inflation or interest rates.
A new paper by economists Adrien Auclert, Hannes Malmberg, Frédéric Martenet and Matthew Rognlie imply that the Goodhart and Pradhan theory is wrong and that the shortage of young Japanese workers will not soon become inflation.
This contributes to substantial evidence that factors such as demographics have driven long-term real interest rates (usually defined as the nominal interest rate minus inflation), with major consequences for investors and central banks around the world.
Auclert and colleagues argue that, yes, an elderly population will reduce its savings. However, aging also reduces growth, which further reduces the demand for investment. Therefore, there will be no return to higher interest rates if the population reaches a certain average age.
If this argument is correct, the decline in interest rates that has been a feature of recent decades is far from over. With the current demographic forecasts as a given, the newspaper’s results imply that aging will reduce real interest rates between 2016 and the end of the 21st century by a percentage point or more.
It is also not just demographics where there is new evidence of the forces pushing interest rates down. In one of the articles delivered this weekend during the virtual Jackson Hole Fed conference, Chicago professor Amir Sufi said new research presented this suggests that rising inequality rates weigh even more than the aging of the demographic.
The mechanism by which inequality can cause falling interest rates is well known: wealthy households have a higher savings rate, so if they get a larger share of total income, total savings increase. More savings relative to investment pushes interest rates.
Sufi and its co-authors note that savings rates vary much more by income than by age, and that even among American baby boomers, the top 10 percent have saved more through income than previous generations, while the other 90 percent save less. has . This suggests that inequality was a larger factor than demographics.
The impact of demographics and inequality may in fact be related, as the more savings a retired household has at its disposal, the less it requires assets to pay for care or cruises in the Mediterranean. But whether inequality or demographics are the biggest cause, there are few signs that both trends are about to turn around.
For investors, downward pressure on real interest rates is a reason to expect asset prices to remain high and returns to be low in the future. An interesting implication of the demographic model is also that different aging patterns can cause new imbalances in current accounts around the world.
This implies an increase in China’s net foreign asset position over the next 30 years, as the country ages, by a US deficit. In the second half of the century, India’s foreign asset position will also rise sharply as demographics begin to change, partly offset by a decline in Japan and Germany – which will then be as old as they are going to be.
For Jay Powell, chairman of the US Federal Reserve, this relentless downward pressure on real interest rates is another reason to be concerned about the recent rise in US inflation. He said in his speech at Jackson Hole that it is no longer calming down, but more likely that these long-term factors will ‘weigh on inflation if the pandemic goes down in history’.
For central bankers in general, this reinforces the case for a higher inflation target, and therefore higher nominal interest rates, so that there is more room to lower interest rates when they are bad.
Back in Japan, where the prospect of reaching any inflation target is as far away as ever, this is bad news for young workers. More work at care homes benefits little if there are fewer at factories and building sites. It looks like the future is ahead.