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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;.

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The Global Macroeconomic Consequences of a Demographic Transition

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  1. 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

  2. Overview • Summary of Global Demographic trends • Macroeconomic issues • Alternative approaches • Consequence of global demographic change in 10 regions from 2004 to 2050 • Conclusions

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. Alternative Approaches • Calibrated/estimated DIGE/DSGE models Bryant/Faraque/Laxton McKibbin/Nguyen/Callen/Battini

  9. 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

  10. 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

  11. Children • 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

  12. 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).

  13. 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.

  14. 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.

  15. 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.

  16. 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

  17. 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.

  18. 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

  19. MSG-Cubed Model: Sectors • Energy • Non-Energy • Capital Producing sector

  20. 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

  21. Question • We want to estimate the overall impacts of demographic change on the global economy from 2005 onwards

  22. Approach • 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

  23. 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.

  24. Figure 8: Contribution to GDP growth of Own versus Global Demographic Change

  25. Figure 10: Contribution to Total Savings of Own versus Global Demographic Change

  26. Figure 11: Contribution to Private Investment of Own versus Global Demographic Change

  27. Figure 12: Contribution to Current Accounts of Own versus Global Demographic Change

  28. Figure 13 : Contribution to Long Term Real Interest Rates of Own versus Global Demographic Change

  29. Implications • 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

  30. 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.

  31. 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

  32. Conclusions • 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

  33. Background Websites www.sensiblepolicy.com www.gcubed.com

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