Monetary Policy In The Gray

Matthew Boesler points to evidence that central banks have less influence in countries where the population skews old:

In [a] paper titled “Shock from Graying: Is the Demographic Shift Weakening Monetary Policy Effectiveness,” IMF economist Patrick Imam links aging populations in countries like the U.S., U.K., Japan, Germany, and Canada to empirical evidence that monetary policy has become less effective. “Based on the life-cycle hypothesis, we would expect older societies to typically have a large share of households that are creditors, and to be less sensitive to interest rate changes, while younger societies would typically have a larger share of debtors with higher sensitivities to monetary policy,” says Imam. And “with fertility rates plummeting around the world – often below replacement rate – including in low-income countries,” the IMF economist writes, “the world is going through an unprecedented demographic shift that is leading to a rapidly graying world.”

Neil Irwin elaborates:

What’s the theory? To start with, monetary policy works by changing the cost of borrowed money.

When growth is weak, a central bank cuts interest rates, which in turn makes spending, consumption, and investment more attractive. You’re more likely to buy a house or a car if the interest rate is 3 percent than if it’s 5 percent, for example. But crucially, the use of borrowed money is a crucial way that these lower rates translate into higher economic growth.

But borrowing money is disproportionately an activity of the young. Economists call it “life cycle hypothesis of saving” – people use credit to smooth out what they can consume over the course of their lives. When just embarking on a career, a young person might take out major loans for education and for buying a house and car. As they reach middle age, they will tend to have paid down some of that debt while also building savings. By the time they hit retirement age, they should be net creditors, with significantly more savings than they still owe in debt.

That would imply that in an older society fewer people are actively using credit products. Which should in turn imply that a central bank turning the dials of interest rates will be less powerful at shaping the speed of the overall economy.

Drum adds:

I can tentatively buy this. In fact, I’d toss out another possible channel for this effect as well: the elderly often live off investments, which means that their incomes fall as interest rates go down. So the bigger the proportion of elderly in a country, the more people you have who are forced to consume less because of low interest rates and the fewer people you have who are motivated to consume more by low borrowing rates.