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One of the great mysteries of Japan’s economy during the 2010s decade of “Abenomics” stimulus was why the rapid ageing of the population did not drive up wages for those of working age. With almost a third of the population aged 65 or above, went the theory, pensioners would surely start to run down their assets, first through spending on fancy meals out and trips to the golf course, then ultimately to pay for care as their health began to fail.
Such spending would translate into demand for the labour of a shrinking pool of younger workers. That would in turn push up wages across the board, and then these rising wages would drive up prices and help the Bank of Japan in its dogged attempt to reach a 2 per cent inflation target after years of trying.
The underlying idea — that population ageing reaches a point where saving for retirement tips over into increased spending and demand for labour — is central to the argument made by economists Charles Goodhart and Manoj Pradhan. They propose that a demographic reversal will turn the current era of stagnant prices into a new age of inflation.
So far, however, it has not played out that way in Japan. Demand for labour has certainly risen: there are nearly four open jobs in Japanese nursing homes for every applicant. But even when the economy was at its strongest around 2018, such demand never turned into higher wages, inflation or interest rates.
A new paper by the economists Adrien Auclert, Hannes Malmberg, Frédéric Martenet and Matthew Rognlie implies that the Goodhart and Pradhan theory is incorrect, and that the shortage of young Japanese workers will not turn into inflation any time soon.
It adds to considerable evidence that factors such as demographics have driven down long-run real interest rates (usually defined as the nominal interest rate minus inflation) with profound implications for investors and central banks across the world.
Auclert and colleagues argue that, yes, an elderly population will run down its savings. However, ageing also reduces growth, which lowers demand for investment by even more. Therefore, there will be no reversal towards higher interest rates when the population reaches a certain average age.
If this argument is correct, then the fall in interest rates that has been a feature of recent decades is not yet over. Taking current demographic forecasts as a given, the paper’s results imply that ageing will drag down real interest rates by a percentage point or more between 2016 and the end of the 21st century.
Nor is it just demographics where there is fresh evidence of the forces that push interest rates downwards. In one of the papers presented at the virtual Jackson Hole Fed conference over the weekend, the Chicago professor Amir Sufi presented new research that suggests rising inequality weighs on interest rates even more than ageing demographics.
The mechanism by which inequality can cause falling interest rates is well known: rich households have a higher savings rate, so when they get a bigger share of total income, overall savings go up. More saving relative to investment pushes interest rates down.
Sufi and his co-authors note that savings rates vary far more by income than they do by age, and that even among the US baby boomers, the top 10 per cent by income saved more than earlier generations while the other 90 per cent saved less. That suggests inequality was a bigger factor than demographics.
The impact of demographics and inequality may in fact be linked, since the more savings a retired household has at its disposal, the less it needs to run down assets to pay for care or Mediterranean cruises. But whether inequality or demographics is the greater cause, there is little sign that either trend is about to go into reverse.
For investors, downward pressure on real interest rates is a reason to expect asset prices to stay high, and returns in the future to be low. Furthermore, an interesting implication of the demographic model is that differing patterns of ageing could cause fresh 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, offset by a US deficit. In the second half of the century, India’s foreign asset position would also rise sharply as its demographics start to shift, offset partly by a decline in Japan and Germany — which, by then, will be as old as they are going to get.
For Jay Powell, chair of the US Federal Reserve, this relentless downward pressure on real interest rates is one more reason to be sanguine about the recent rise in US inflation. Rather than abating, he said in his speech at Jackson Hole, it is more likely that these long-run factors “will continue to weigh on inflation as the pandemic passes into history”.
For central bankers in general, it strengthens the case for a higher inflation target, and thus higher nominal rates, so there is more room to cut rates when times are bad.
Back in Japan, where the prospect of hitting any kind of inflation target is as remote as ever, that is bad news for young workers. More jobs at care homes do little good if there are fewer at factories and building sites. That, it seems, is what the future has in store.