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The Global Macroeconomic Consequences of a Demographic Transition. Warwick J McKibbin Centre for Applied Macroeconomic Analysis, RSPAS, ANU; Lowy Institute for International Policy, Sydney The Brookings Institution, Washington DC;.

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the global macroeconomic consequences of a demographic transition

The Global Macroeconomic Consequences of a Demographic Transition

Warwick J McKibbin

Centre for Applied Macroeconomic Analysis, RSPAS, ANU;

Lowy Institute for International Policy, Sydney

The Brookings Institution, Washington DC;

Prepared for a seminar at the Harvard Program on the Global Demography of Aging. Cambridge Mass Thursday, February 23

  • Summary of Global Demographic trends
  • Macroeconomic issues
  • Alternative approaches
  • Consequence of global demographic change in 10 regions from 2004 to 2050
  • Conclusions
main macroeconomic impacts
Main Macroeconomic Impacts
  • Aggregate saving, consumption, wealth
    • Composition of consumption bundles
  • Investment rates
      • aggregate
      • across sectors
  • Labor markets
  • Government budgets
  • => General equilibrium impacts on trade and financial flows and asset prices including real exchange rates
macroeconomic impacts
Macroeconomic Impacts
  • What happens to the current account on any country depends on the impact on savings relative to investment
    • A rise in savings relative to investment will tend to improve the current account
    • A fall in savings larger than a fall in investment will tend to worsen the current account
alternative approaches
Alternative Approaches
  • Cross sectional/time series econometric estimation of aggregate saving and investment and growth equations or current accounts
  • Higgins (1998), Masson et al (1998), Helliwell (2004), IMF (2004)
  • Tend to find negative impact of dependency rates on investment, savings and the current account
alternative approaches1
Alternative Approaches
  • Vector Autoregression models with demographic and economic variables (Kim and Lee (2005)
  • Strong negative impact of dependency rates on saving
  • Strong negative impact of dependency rates on current account
alternative approaches2
Alternative Approaches
  • Calibrated OLG models of single economies and multiple economies
    • Brooks (2005), Ingenue (2004)
  • Calibrated CGE models of global economy
    • Tyers (2005) using GTAP
alternative approaches3
Alternative Approaches
  • Calibrated/estimated DIGE/DSGE models



theoretical approach
Theoretical Approach
  • Follows Yaari/Blanchard/Weil models as extended by Faruqee, Laxton, Bryant, McKibbin and others
  • Demographics from the “bottom up”
    • Approximate an OLG model using a probability of death and exogenous profiles of birth and death rates to generate cohort adjustment over time
    • The demographic change is taken as exogenous and cohort aggregation effects are calculated outside the core model
minimum requirements
Minimum Requirements
  • Adults are distinguished from children so we can capture the importance of changes in the youth dependency ratio
  • Country specific models for the major countries/regions so we can capture the asymmetries
  • Are born to adults and stay children for 16 years
  • Do not supply labour
  • Do not hold financial wealth
  • Receive transfers from adults (which grow at the rate of economy wide productivity growth) which they consume
  • Have a different birth rate (defined as the number of children as a percent of the adult population) than the adult maturity rate (defined as the number of new adults as a percent of the adult population)
  • Have a different mortality rate than adults
adults workers
  • Emerge at age 17 from the pool of children
  • The adult maturity rate is the rate of emergence of adults as a percent of the total adult population
  • Are born with the productivity of the cohort alive in time t and then acquire productivity based on the estimate age earnings profiles over time.
  • Die at a constant rate over time (major shortcoming but needed for aggregation).
introduce empirical age earnings profiles
Introduce empirical age earnings profiles
  • Labor income
    • rises with age and experience
    • reaches a peak in late middle age
    • then declines gradually for the rest of life
  • The shape of the age-earnings profile for individuals in the economy is assumed to be the same for all individuals and unchanged through time.
introduce empirical age earnings profiles1
Introduce empirical age earnings profiles
  • But the demographic composition of the population can change over time.
  • Because aggregate labor income is obtained by aggregating over individuals that differ in age and experience, moreover, the bottom-up aggregation over individuals permits the demographic changes to influence both the aggregate level and the age distribution of labor income.
introduce empirical age earnings profiles2
Introduce empirical age earnings profiles
  • The hump-shaped profile of earnings by age influences both the supply side and the demand side of the model economy's behavior.
  • Hence through these life-cycle effects, changes in demographics significantly influence macroeconomic outcomes.
supply side effects
Supply side effects
  • On the supply side, the earnings profile is an indicator of the changes in a cohort's relative productivity and its supply of labor over its lifetime.
  • The marginal product of capital will change and investment will respond
demand side
Demand Side
  • On the demand side, the anticipated path of labor income determines the saving plans of consumers over their lifetimes.
  • Changes in investment will change the demand the goods.
msg cubed model countries
MSG-Cubed Model: Countries
  • Japan
  • USA
  • Western Europe
  • Rest of OECD
  • Eastern Europe and the Former Soviet Union
  • China
  • India
  • Other Asia
  • Latin America
  • Other Developing Countries
msg cubed model sectors
MSG-Cubed Model: Sectors
  • Energy
  • Non-Energy
  • Capital Producing sector
msg cubed model
MSG-Cubed model
  • Estimated dynamic intertemporal model with Keynesian short-run rigidities
    • Adjustment costs in capital accumulation
    • Financial capital mobile given risk premia
    • Wages adjust slowly given labour market rigidities
    • Financial markets for equity, bonds, money
    • Mix of optimizing and rule of thumb decision rules
  • We want to estimate the overall impacts of demographic change on the global economy from 2005 onwards
  • Develop a baseline projection of the global economy from 1985 to 2100 with a full demographic transition where countries are adjusting towards a common steady state with the same birth and death rates but from very different initial conditions
calculating the impact of demographic change
Calculating the Impact of Demographic Change
  • Solve the model again from 1985 to 2100 setting the birth rates of children at the steady state rates
    • The initial conditions in 1985 will already have the expectations of a demographic transition in the initial asset stocks.
    • Allow some time for the asset adjustment to occur
    • then examine the difference between the results with and without the demographic transition from 2005.
  • Several adjustment mechanisms possible
    • Reallocate inputs within economies
    • Raise productivity growth to generate more resources to deal with macroeconomic adjustments
  • In an open economy
    • Allow labor to flow across borders from labour abundant into labour scarce countries
    • Allow goods which embody labour to flow from labour abundant countries into labour scarce countries
    • Allow capital to flow from labour scarce countries to labour abundant countries
policy implications to be explored further
Policy Implications to be explored Further
  • Open economies to international trade so that more labour can be imported into labour scarce countries embodied in goods
  • Deregulate protected sectors such as the service sector in economies such as Japan to raise productivity growth and free up scarce labour
  • Allowing greater capital mobility (and better allocation of capital) so that capital can flow to labour rather than labour flow to capital.
policy implications
Policy Implications
  • Batini, Callen and McKibbin (2005) find that raising productivity growth and reducing the risk of investing in developing countries can swamp the macroeconomic impacts of demographic change
  • Demographic change projected over the next century has a significant impact on aggregate economic variables within countries as well as economic outcomes between countries
  • It is not sufficient to examine demographic change in a country without some allowance for what is happening in the world as a whole
background websites
Background Websites