To anyone who lived through the inflation-wracked 1970s, the question might seem surreal: Could the United States experience falling consumer prices and the corresponding drop in stock prices that typically accompanies deflation?
Over the quarter-century since Japan became ensnared in a tenacious deflationary spiral, the possibility of outright deflation in the U.S. has been viewed by many economists as almost as likely as a renewed outbreak of unacceptable inflation. And given that the average Japanese stock is still 50% lower today than 25 years ago, it’s a question of prime importance to investors.
Especially, that is, since the demographic factors that are believed to underpin Japanese deflation also are at work in the United States, albeit to a lesser degree. According to the U.S. Census Bureau, 60% of the U.S. population in 2010 was between the ages of 20 and 64; by 2030, that number is projected to drop to 55%, mostly because of retiring baby boomers.
The so-called Age Dependency Ratio has important implications because people at the low and high ends of the demographic spectrum contribute less to the consumer spending that accounts for 70% of U.S. economic output. Reduced economic activity, in turn, could slow corporate earnings growth and restrain the demand for goods and services that would keep prices from falling.
So it is with interest that we examine the findings of economists Mikael Juselius and Előd Takáts from a working paper published by the Bank for International Settlements (BIS). The duo’s research did uncover a statistically significant correlation between demography and inflation, but not the correlation that economists had expected.
Juselius and Takáts explored the relationship between demography and inflation in 22 advanced countries from 1955 to 2010. They begin by noting that the recent emergence of a demographic explanation for the sharp fall in inflation since the 1970s arose in response to the apparent failure of central banks to raise inflation from the dangerously low levels that prevailed following the global financial crisis in 2008.
If high interest rates slew the inflationary dragon in the 1980s, why has easy money been unable to vanquish deflation now?
The answer, the authors posit, is that the relationship between “dependents” and those in the labor force has a counterintuitive effect on prices. Even though seniors clearly consume less than they did during their working years, they — in combination with the youngest segment of a population — nonetheless consume more than a shrinking workforce usually produces, thus causing prices to rise, or at least not fall. “A larger share of dependents (i.e, young and old) is correlated with higher inflation,” they wrote, “and a larger share of working age cohorts is correlated with lower inflation.”
But given that the global population is aging, why have central banks been unable to raise inflation to more comfortable levels via ultra-low interest rates? The authors provide a complicated explanation that might be boiled down to an inconsistent application of monetary policy as it relates to shifting demographics.
Juselius and Takáts acknowledge that their findings are preliminary and that more research is needed to better understand how demographic patterns can inform monetary policy to achieve a desired rate of inflation. In the meantime, investors can take comfort in the likelihood that the graying of America won’t by itself cause the U.S. to follow Japan into the deflationary abyss.
Which is fine, since none of us is likely to get any younger.