As the Country Ages, the Federal Reserve Becomes Less Powerful

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Neil Irwin writes today about a new theory from Patrick Imam of the IMF suggesting that central banks may have less and less influence over the economy as the population of a country ages:

What’s the theory? To start with, monetary policy works by changing the cost of borrowed money….But borrowing money is disproportionately an activity of the young….That would imply that in an older society fewer people are actively using credit products. Which should in turn imply that a central bank turning the dials of interest rates will be less powerful at shaping the speed of the overall economy.

Imam tested this theory by looking at how much the effectiveness of monetary policy had changed across countries as compared with those countries’ demographics. And he indeed found an impact: A one-percentage-point increase in the “old-age dependency ratio” (the share of the population that is elderly) lessens the effectiveness of monetary policy in affecting inflation by 0.1 percentage points and unemployment by 0.35 percentage points.

I can tentatively buy this. In fact, I’d toss out another possible channel for this effect as well: the elderly often live off investments, which means that their incomes fall as interest rates go down. So the bigger the proportion of elderly in a country, the more people you have who are forced to consume less because of low interest rates and the fewer people you have who are motivated to consume more by low borrowing rates.

I’ve never been in the camp that thinks monetary policy can be made infinitely effective in the first place, so this doesn’t change my personal views too much. Basically, in a downturn you need more government spending along with a Fed promise not to offset it with higher interest rates. Neither one by itself is as effective as both together. It’s too bad we all gave up on that idea in 2010. We’ve been paying the price ever since.

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