The fertility rate in industrialized countries dropped in the early 1970’s, while at the same time, life expectancy increased steadily. As a result, there are fewer working-age people to support the dependent consumer portion of the population, those under age 15 and over the age of 65.
This shift in balance between those who produce and those who consume will affect the level of inflation and interest rates.
Demography and Inflation
Baby boomers are quickly moving towards retirement while an even larger generation of millennials are entering the workforce. Since different cohorts behave differently with respect to savings and consumption decisions, we can expect demographic changes to influence inflation and the supply and demand balance of capital.
According to an IMF1 study that looked at 22 developed countries between 1955 and 2014, inflation manifests itself when a portion of the population consumes more than it produces, i.e., the younger and older populations outnumber the population in the labour market. This is what is happening now. There are fewer workers supplying the massive need for products and services of the other cohorts, putting upward pressure on prices.
Demographic changes explain almost a third of the variations in inflation and the bulk of the inflation trend.
Demography and Interest Rates
Over the last 20 years, boomers have found themselves in the midst of their wealth accumulation period, partly accounting for the downward trend in interest rates. As they enter retirement, they will gradually spend their savings to meet their growing consumption needs. In fact, health costs tend to grow rapidly as you get older, which explains the increased expenses in the latter years.
As a result, the period when the population aged 35 to 65 (savers) was at its lowest level, i.e., when few were saving, corresponds to the time when interest rates peaked. In contrast, when more people were saving, interest rates dropped, resulting in a surplus of available capital relative to ongoing investment projects.
Today, the cohort at the peak of their working life is small compared to the group whose consumption exceeds income. Baby boomers will reduce their savings at the same time as an even bigger generation will have to borrow to start a family, buy a house, furniture, a car and so on. These changes should favour creditors at the expense of borrowers who will see their cost of capital rise.