James Bevan: Inflation and demographics
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James Bevan
When I visited a prospective client recently, I was asked to describe the economic scenario that worries me the most. I answered that while I believe it is very unlikely, a surge in inflation would be very bad news for all of us. It would force central bankers to normalize monetary policy in a more normal (i.e., aggressive) fashion, it would kill the bond market, which would seriously wound the bull market in stocks and, in this scenario, the next recession would happen sooner rather than later.
While it may be unlikely, it is a conceivable scenario for next year if we get a big pick up in government spending on say infrastructure, and this is a possible scenario across a range of economies.
But the risk is that if there is a surge in spending which succeeds in boosting the economy and inflation, then central banks’ reactions may then quell recovery, forcing a return to no more than slow growth path, which remains our central scenario — and that path is consistent with demographic trends.
As for the outlook for inflation, there is a rising tide of media commentary, including a Bloomberg article Inflation Outlook Rises Everywhere But Japan. In practice, not much has changed in the global landscape thus far this year, other than that oil prices have rebounded somewhat.
Wage inflation remains subdued, and so do overall core inflation rates. The US core CPI and core PCED rose 2.2% year-on-year (yoy) and 1.7% through September — they’ve both been around these respective readings for some time. Euroland’s October CPI flash estimate was 0.5%yoy – the highest since June 2014 and the core rate remained at 0.8%. Japan’s core CPI was -0.5%yoy through September, while the so-called core-core rate was +0.1%.
Demographics
We worry about stagflation in the UK but there isn’t enough inflation in the global economy to describe the current situation as stagflationary. However, there seems to be plenty of secular stagnation, and mounting evidence that it is connected to changing demographics. Across a range of economies, people are living longer, younger generations are deferring having children and are having fewer children than their parents did. These factors are creating significant shifts in age compositions of population.
Focusing on the US, the Census Bureau’s March 2016 report titled An Aging World reveals that the older dependency ratio (the number of people aged 65+ per 100 people aged 20 to 64) is projected to increase from 25 during 2015 to 37 during 2030. The population that is 65+ as a percentage of the work force has increased from 23.6% to 30.2% over the past 10 years. The percentage of the population aged 65+ is expected to increase from 14.9% in 2015 to 22.1% by 2050 vs 1980s percentage of 11.2%. The Census Bureau reckons that Maine and Florida will likely end this year with more elderly residents than children.
On the issue of ageing, the Census Bureau say that US life expectancy at age 65 has increased from about 12 years at the turn of the century to about 19 years in 2010. But the healthy life expectancy (HALE) of those aged 65+ was about 14 years for the average of both sexes taken together for the period from 2007 to 2009. That suggests an uncomfortable last five years.
At the other end, the US National Center for Health Statistics (NCHS) has, since 1909, tracked the so-called “general fertility rate,” which is the number of births out of 1,000 women between the ages of 15 and 44. Back in 1957, the fertility rate was 122.9 but by Q1 2016, it was down to just 59.8, the lowest on record, and the average age of first-time mothers is up from 24.9 in 2000 to 26.3 in 2014.
New normal
Economists at the Federal Reserve are concerned that demographic factors associated with the post-war Baby Boomers will translate into less real GDP growth in the coming decades, according to an August 2016 working paper titled Understanding the New Normal: The Role of Demographics.
The Fed found that low real GDP growth since the Great Recession was “largely predictable” based on their demographic model, which takes into account family composition, life expectancy, and labour market activity. They concluded: “Our results further suggest that real GDP growth and real interest rates will remain low in coming decades, consistent with the U.S. economy having reached a ‘new normal.’”
Economists at the National Bureau of Economic Research (NBER) came to a similar conclusion in a July 2016 working paper titled The Effect of Population Aging on Economic Growth, the Labor Force and Productivity. It projected that annual GDP growth will slow by 1.2ppt during this decade due to population aging, with ageing pre-determined by historical declines in fertility. They attributed two-thirds of the anticipated decline in GDP to “slower growth in the labor productivity of workers across the age distribution,” and one-third to “slower labor force growth.” The civilian labour force participation rate peaked during early 2000 at 67.3% and is currently down to 62.9%. Brookings say that nearly half of the decline in the participation rate between Q4 2007 and mid-2014 was attributable to the ageing population, and have projected “further declines in the aggregate labor force participation rate as the most likely outcome.”
As to why productivity falls, there are several explanations. The NBER paper observed: “An older worker’s experience increases not only his own productivity but also the productivity of those who work with him,” and the Wall Street Journal has commented that productivity peaks at age 50 when productivity is 60% higher than for the average 20-year-old. The concept is especially true in industries that require more cognitive thinking, or soft-skills, which ripen with age.
Homes and ageing
One unknown is what the implications are for housing markets. It’s possible that homeownership rates go down as more of the elderly move into assisted-living facilities and nursing homes, and even if they continue to own, older people tend to downsize putting pressure on more expensive housing, unless there is enough offsetting demand from younger adults. The Economist wrote an article “showing that house prices fell by 0.2 percent per year as age-dependency ratios increased in a sample of 10 countries”. The St Louis Fed has written: “Because the demographic composition of the labor force contributes strongly to the trend in house prices, fewer young people, together with a large increase in the elderly population, would likely result in less investment in the housing market.”
As for indebtedness, older people tend to take on less risk and less debt than younger ones, and older people may be less inclined to spend more when interest rates are low, especially if fixed-income assets are low yielding. Meanwhile, Arlene Wong of Northwestern University wrote a paper titled Population Aging and the Transmission of Monetary Policy to Consumption which concluded: “The consumption of young people is significantly more responsive to interest rate shocks than the old, and explains most of the aggregate response [to such shocks]. The consumption responses are driven by homeowners who refinance or enter new loans after interest rate declines.”
In a broadly similar vein, the Fed’s vice chair Stanley Fischer made a speech in October in which he argued that demographic factors are largely responsible for low interest rates, and that the aging population is likely to “boost aggregate household saving” because older groups, particularly those approaching retirement, typically have “above-average saving rates.” Fischer reckoned that population aging through its effects on saving could be pushing down the longer-run equilibrium Federal Funds rate relative to its level in the 1980s by as much as 75 basis points.
On the spending front, the composition of what’s paid for varies with age too although the exact pattern is not clear and is changing. There was a conference in October called Aging 2.0, at which Google’s Jennifer Haroon discussed how self-driving cars could “make a tremendous difference in older adults’ lives” by transforming their mobility. If innovations like these are able to deliver what they promise, that might help to stem some of the negative effects of the population’s inevitable aging, and represent an excellent long term investment opportunity. On an ongoing basis, we will retain a focus on opportunities that either support the elderly or make them feel young again, as with health-care-related industries, such as bio tech, long-term care insurance, and assisted living communities.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
*CCLA is a supporter of Room151
