1
Macroeconomic Impacts of Demographic Change
Warwick J McKibbin
Centre for Applied Macroeconomic Analysis, RSPAS, ANU;Lowy Institute for International Policy, Sydney
The Brookings Institution, Washington DC;
Presentation prepared for the USDA Workshop on Demographic Change and the Global Food System, Washington DC 25 May 2005
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Draws on
• McKibbin W. and J. Ngyuen (2004) “Modeling Global Demographic: Change Results for Japan”, CAMA working paper 4/2004
• Battini N., CallenT. And W. McKibbin (2005) “The Global Impact of Demographic Change” IMF working paper – background paper to the September World Economic Outlook (Forthcoming)
• McKibbin (2005) “Global Demographic Change and Japanese Macroeconomic Performance” Paper prepared for the ESRI collaborations Project conference, Tokyo, 14-16 February
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Overview
• Summary of Global Demographic trends• Goal of the Project• Macroeconomic issues• Alternative approaches• Our Approach• Results for stylized fertility decline in a 2 country model• Consequence of demographic change in 10 regions from
2004 to 2100• Conclusions
Source IMF World Economic Outlook September 2004
Source IMF World Economic Outlook September 2004
Source IMF World Economic Outlook September 2004
Source IMF World Economic Outlook September 2004
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Goal of the Project
• Study the global macroeconomic consequences of demographic change with a focus on the likely consequences for saving and investment balances (therefore current accounts) and asset prices over time
• Develop policy recommendations for national governments for how best to cope with these changes
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• We take it as given that to understand the international dimensions of demographic change you need to use some form of global economic model.
• But existing models are inadequate in that they do not adequately include demographic factors
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Macroeconomic Impacts of demographic change
• 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
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Alternative Approaches
• Cross sectional/time series econometric estimation of aggregate saving and investment and growth equations
• Calibrated OLG models of single economies
• Calibrated/estimated DIGE/DSGE models
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The Approach
• Improve and apply the new generation of large scale global economic models to capture the many complex general equilibrium issues.
• Based on a short cut approach to demographics in a dynamic stochastic general equilibrium (DSGE) model rather than an explicit multi-country overlapping generation (OLG) model
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The Steps
• Develop small scale versions of the larger models for development purposes
• Develop and apply new theoretical and empirical research in the small scale general equilibrium models
• Extend the research into more realistic large scale models.
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The Models Used
• We are taking a two-pronged approach doing the analytical/empirical work together but implementing in two strands of models– Bryant working with his version of the IMF Multimod
model– McKibbin and co-authors working with the MSG3 and
G-Cubed models
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Our Theoretical Approach
• Follows Yaari/Blanchard/Weil models as extended by Faruqee and Laxton
• 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
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Minimum Requirements
• Adults are distinguished from children so we can capture the difference between youth and elderly dependency ratios
• Country specific models for the major countries/regions so we can capture the asymmetries
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Summary of the theoretical approach
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Introduce an age earnings profile
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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.
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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.
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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.
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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.
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Demand Side
• On the demand side, the anticipated path of labor income determines the saving plans of consumers over their lifetimes.
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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).
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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
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Simple Model
• First consider a symmetric 2 country MSG3 model with demographics
• Both countries are the United States– UU is United States– ZZ is foreign country
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Consider a stylized shock
• Japan size fall in the birth rate– Closed economy (shock occurs in both countries)
– Open economy (shock occurs in ZZ economy)
Figure 3 Stylized Shocks to Adult and Child Birth Rates
-1.4
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
1 21 41 61 81 101 121 141
Simulation Period (Year)
Perce
nta
ge
Poin
ts
Adult Birth Rate Child Birth Rate
Figure 3Effective Labour Supply and Population Profiles for a decline in
Japanese Fertility
-90
-80
-70
-60
-50
-40
-30
-20
-10
0
1970 1990 2010 2030 2050 2070
Simulation Period (Year)
Pe
rce
nta
ge
De
via
tio
n F
rom
Ba
se
line
(%
)
Adult Population
Child Population
Effective Labour Supply
Figure 4 : Implications of a Fertility Decline - Closed Economy versus Open Economy - Theoretical Model
Aggregate Real GDP
-90
-80
-70
-60
-50
-40
-30
-20
-10
0
10
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Aggregate Real Consumption
-80
-70
-60
-50
-40
-30
-20
-10
0
10
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Current Account
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
devi
atio
n as
% o
f ba
selin
e G
DP
Trade Balance
-1.5
-1
-0.5
0
0.5
1
1.5
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
devi
atio
n as
% o
f ba
selin
e G
DP
Figure 5 : Implications of a Fertility Decline -Closed Economy versus Open Economy - Theoretical Model
Real GDP per Adult
-60
-50
-40
-30
-20
-10
0
10
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Adult Consumption per Adult
-35
-25
-15
-5
5
15
25
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Capital/Output Ratio Sector 2
-70
-60
-50
-40
-30
-20
-10
0
10
20
30
40
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Tobin's Q Sector 2
-16
-14
-12
-10
-8
-6
-4
-2
0
2
4
6
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Figure 6: Implications of a Fertility Decline -Closed Economy versus Open Economy - Theoretical Model
Real Interest Rate
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%po
int
Dev
iatio
n fr
om b
asel
ine
Real and Nominal Exchange Rate(+ve is ZZ appreciation)
-25
-15
-5
5
15
25
35
45
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed real nominal
%
Dev
iatio
n fr
om b
asel
ine
Ratio of Imports to GDP
-2
0
2
4
6
8
10
12
14
16
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
%
Dev
iatio
n fr
om b
asel
ine
Net Foreign Assets
-80
-60
-40
-20
0
20
40
60
80
1 11 21 31 41 51 61 71 81 91101111121131141151161
Closed US ZZ
% b
asel
ine
GD
P d
evia
tion
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Summary
• Promising approach to incorporating demographics into global models.
• Results suggest important implications of demographic change for asset prices and balance of payment adjustment – even when the coming shocks are anticipated.
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Analytical Approach
• Embed the “short cut: approach of Bryant et al (2003,2004) and McKibbin and Nguyen (2004) into the MSG3 model with 10 regions.
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Sectors
• Energy• Non-Energy
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Countries
• Japan• USA• Western Europe• Rest of OECD• Eastern Europe and the Former Soviet Union• China• India• Other Asia• Latin America• Other Developing Countries
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Question posed and philosophical issues
• We want to know the 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 demographic position from very different initial conditions
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SImulations
• The baseline will be changing over time because of a range of factors such as productivity growth and demographic change. We want to calculate just the impact of demographic change over the coming century
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Calculating the Impact of Demographic Change
• Solve the model again from 1985 to 2100 removing the demographic adjustment from 1985– 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.
Figure 3: Removing the Demographics(A stylized Representation)
-1
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
1985 1994 2003 2012 2021 2030 2039 2048 2057 2066 2075 2084
po
pu
lati
on
gro
wth
Developing countries
Industrial countries
No Demographics
baseline projection
Child Birth Rate
-2
-1
0
1
2
3
4
5
6
1985
1995
2005
2015
2025
2035
2045
2055
2065
2075
2085
2095
2105
2115
2125
2135
2145
2155
2165
2175
2185
per
cen
tag
e d
evia
tio
n f
rom
ste
ady
stat
e
USA
Japan
Europe
ROECD
Asia
Latin America
India
China
FSU
DCs
Adult Maturity Rate
-1
-1
0
1
1
2
2
3
3
1985
1995
2005
2015
2025
2035
2045
2055
2065
2075
2085
2095
2105
2115
2125
2135
2145
2155
2165
2175
2185
per
cen
tag
e d
evia
tio
n f
rom
ste
ady
stat
e
USA
Japan
Europe
ROECD
Asia
Latin America
India
China
FSU
DCs
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Focus on Japan: Impacts on Japan of Japanese demographic change versus rest of world demographic change
Figure 1: Contribution of Demographic Change in All Countries to Japanese Growth Rate
Japan GDP growth
-1.4
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
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90
20
95
21
00
% p
oin
t c
ha
ng
e
All countries Japan
Japan GDP growth
-0.08
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
% p
oin
t c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
Figure 2: Contribution of Demographic Change in All Countries to Japanese Current Account
Japan Current Account/GDP
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
20
05
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90
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95
21
00
% b
as
eli
ne
GD
P c
ha
ng
e
All countries Japan
Japan Current Account/GDP
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
20
05
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21
00
% b
as
eli
ne
GD
P c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
Figure 3: Contribution of Demographic Change in All Countries to Japanese Trade Account
Japan Trade Account/GDP
-4
-3
-2
-1
0
1
2
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90
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95
21
00
% b
as
eli
ne
GD
P c
ha
ng
e
All countries Japan
Japan Trade Account/GDP
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
20
05
20
10
20
15
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20
90
20
95
21
00
% b
as
eli
ne
GD
P c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
Figure 4: Contribution of Demographic Change in All Countries to Japanese Real Exchange Rate
Japan Real Exchange Rate
-10
0
10
20
30
40
50
60
20
05
20
10
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15
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00
% p
oin
t c
ha
ng
e
All countries Japan
Japan Real Exchange Rate
-6
-4
-2
0
2
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8
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% p
oin
t c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
Figure 5: Contribution of Demographic Change in All Countries to Japanese Real Interest Rates
Japan Short Real Interest Rate
-1.6
-1.4
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
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0.4
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% p
oin
t c
ha
ng
e
All countries Japan
Japan Short Real Interest Rate
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2
% p
oin
t c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
Figure 6: Contribution of Demographic Change in All Countries to Japanese Private Investment
Japan Private Investment
-20
-15
-10
-5
0
5
10
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% b
as
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ne
GD
P c
ha
ng
e
All countries Japan
Japan Private Investment
-2
-1.5
-1
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0
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1
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% b
as
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GD
P c
ha
ng
e
USA Eur OEC Chi Ind Asi Lam Eeb ldc
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Conclusions
• Results are very preliminary• Demographic change projected over the next century, as
modeled, seems to have 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– For example the impact of demographic change in
Japan is significant but so is the impact of demographic change in other countries on Japan
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Next Steps
• Incorporate the theoretical approach into the G-Cubed model with 12 sectors to capture relative price effects of demographic changes
• Expand the variety of consumers to allow different consumption bundles by age.
• Incorporate imperfections in social security systems
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Background Websites
www.sensiblepolicy.com
www.gcubed.com
