Expert Commentary

Octogenarian Deflation

Policy makers don't understand why price inflation is low. Do demographic trends provide an answer?

Central bankers are increasingly nervous about the fact that the rate of growth in consumer prices (commonly referred to as inflation) is stagnant. Try as they have by creating money out of thin air via quantitative easing (the real definition of inflation), consumer prices in developed economies are not rising as quickly as policy makers think they should. As the chart below shows, expectations of the rate of growth of consumer prices have declined markedly over the past year. This renewed concern -has focused some attention on whether the chronic condition is due to the fact that developed societies are aging. We looked at the evidence.

The life-cycle hypothesis assumes that individuals plan their consumption and savings behavior over their life-cycle. They intend to even out their consumption in the best possible manner over their entire lifetimes, doing so by saving when they earn and dis-saving in later life when they are not earning. Thus, the net effect on economic growth trends should be neutral. Sounds straightforward in theory but, as usual, in reality it is much more messy. The effects of demographic trends can significantly alter this nice model. In a nutshell, as populations age, and the ratio of older (non-earners) to younger (earners) goes up, economic growth, in general, will slow. Does that mean that the growth rate of prices of goods and services will also slow?

Japan is the obvious case that people point to. The land of the rising sun has faced an aging population issue for decades and price inflation has remained chronically subdued, with regular periods of price deflation. However, as anyone who has ever been there will testify to, Japanese society is joyously unique and unlike any other country on the planet. Japan's experience may not be applicable to others.

The academic literature studies various country and economic statistics in order to examine any link between demographic trends and price inflation. Three papers, Anderson et al (2014), Yoon et al (2014) and Bobeica et al (2017) found that aging populations lead to significant price deflation effects. However, Juselius and Takáts (2018) found that price inflation trends generally follow the life-cycle hypothesis when it comes to demographics. The paper states "...inflationary pressure rises when the share of dependents increases and, conversely, subsides when the share of working age population increases." In other words, the more workers there are, the more savers there are and so price inflation is subdued; and the less workers there are, the more spenders there are and price inflation grows. Nevertheless, the paper finds that when aging is extreme, when the share of 80+ year olds is significant, price deflation effects are marked. Overall, the academic evidence presents a certain amount of ambiguity but one conclusion is very clear -- when societies become very old, price deflation is severe.

As socionomists, we believe that the biggest influence on the cycles of inflation and deflation is the unconscious, herding cycles of social mood. Indeed, fertility rates and, therefore, demographic trends themselves are driven by cycles in social mood. Notwithstanding, if central bankers around the world are worried about persistently low price inflation, they should take a look at the octogenarian trend in their society.

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