The Strategist

Study finds reasons for low inflation

06/04/2018 - 14:25

Economists and central banks are trying to find out why acceleration of large economies is not accompanied by an acceleration of inflation. There are different theories, such as globalization, development of Internet commerce, weaker influence of trade unions, and so on. This is a mystery, former US Federal Reserve Chairman Janet Yellen admitted.

The solution may lie in changing the age structure of the population, suggested the senior economist of the Bank of Finland Mikael Juselius and the senior economist at the Bank for International Settlements (BIS) Elod Takats, after studying inflation data in 22 OECD countries from 1870 to 2016. This factor, together with the gap between actual and potential GDP and real interest rates determined almost half (48%) of inflation before the First World War (1870-1913), and between wars (1922-1938), and in the post-war period (1950 -1989), the economists found out. The periods of hyperinflation - two world wars and the next three years - were excluded from the calculations.

Increase in the share of dependents - people under the age of 20 and over 64 - accelerates inflation, and growing proportion of the able-bodied population slows it down, the study showed. In the US, the generation change from the 1950s to the 1970s accelerated inflation by 7%, and from the 1970s to the 2000s, it slowed down, the authors note.

The global financial crisis of 2008 is similar to the Japanese crisis of the early 1990s, writes Juselius and Takats: both started when the share of "dependents" in the economy was minimal, and both were followed by a period of low inflation and an increase in the proportion of older ages.

Elderly people are "pure consumers". They do not produce, but spend as much as in active age, heating demand and rising prices, the BIS report said. And employers are forced to raise their salaries due to a reduction in the working-age population and a shortage of staff, which also leads to higher prices, Morgan Stanley pointed out. 

Long-term inflationary pressures can at least partially be predicted, concluded Juselius and Takats, as the age composition of generations can be predicted. In the past 50 years, growth in the proportion of able-bodied people slowed inflation by an average of 3 pp, they calculated. Now the share of young people is declining, compensating for the growth in the proportion of the elderly - this keeps inflationary pressures at historic lows. But in the next 50 years, the proportion of the elderly will grow and accelerate inflation, on average, by 3 pp as well.

The age structure of the population influences policy of central banks: young people are more likely to take out loans, save less, and therefore are less interested in low inflation, Juselius and Takats note. Savings are most active only 50-59-year-olds, they write.

It is assumed that central banks can give too much attention to the problem of expectations in their policies: inflation expectations by 16% are determined by the composition of generations. This hypothesis has yet to be studied: even developed countries target inflation relatively recently.