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Demographics and long-term inflation – an economists view - featured image

Demographics and long-term inflation – an economists view

Two major long term drivers of our economy have been inflation and our population growth

But what's ahead now?


The large demand shock from the Coronavirus pandemic will keep inflation low, both here in Australia and globally.

At the same time immigration will be low in the short term.

So how will these factors affect our markets moving forward?

The economists at NAB addressed these issues in a recent economic update.

The also examine a concept that a looming major demographic change may lead to inflation.

Here's what the had to say....

NAB and the RBA expect inflation will stay below 1.5% to the end of 2022

Inflation is expected to be quite low for some years, barring some volatility due to temporary supply chain disruptions and the introduction and removal of temporary government subsidies.

This is because demand is expected to be weak for some time, while high unemployment means wages growth will slow, limiting price pressure.

NAB forecasts economic activity will only recover to pre-virus levels in late 2022.

As such, unemployment will rise sharply over the next 36 months and remain generally elevated for some time.

This suggests that wages are likely to slow in the near term, given the elevated unemployment rate means job seekers and current employees will have limited bargaining power.

Additionally, NAB note little price pressure from abroad.

Over the next few years a higher Australian dollar and weak economic activity overseas suggests the price of imports (including oil) will not rise sharply.

This means there is likely only limited cost pressure from import prices.

Therefore, NAB forecasts core inflation to slow to 1% by the end of 2021.

As economic activity recovers and unemployment falls, disinflationary pressure will ease.

Eventually, following a sustained recovery in activity and unemployment, inflation will begin to rise again.

But this will take some years, especially as the near-term path of the recovery remains highly uncertain.

Inflation expectations have shifted dramatically over this year

Since the start of the coronavirus pandemic, inflation expectations have shifted dramatically.

Short-to medium-term inflation expectations have fallen, while long-term expectations have collapsed then risen.


The fall in near-term expectations is unsurprising given the large economic shock from the pandemic, where demand has collapsed, unemployment has spiked, and oil prices have fallen sharply.

More interesting is the recovery in long-term expectations.

In part, this may reflect the market expectation that the US Federal Reserve (Fed) will relax its inflation mandate to target an average inflation rate of 2%, thereby implying the Fed will tolerate periods of above-target inflation.

The move also reflects a growing discussion in some quarters that long-term disinflationary forces have played out and may even reverse.

Long term outlook - demographic reversal to support inflation?

Recently, debate on how inflation is influenced by long-term demographic trends has resurfaced.

This has been sparked, in part, by an upcoming book The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival by Charles Goodhart and Manoj Pradhan.


Goodhart was part of the Bank of England's monetary policy committee; Pradham was formerly the head of the global economics team at Morgan Stanley.

While the book is not yet released, we discuss an earlier 2017 working paper by the pair: Demographics will reverse three multi-decade global trends.

Goodhart and Pradhan’s central thesis is that the significant demographic shifts over the past 35 years are key to understanding the long-term declines in real interest rates and inflation, as well as the rise in within- country inequality. We focus on their discussion of real interest rates/inflation.

The authors point to two major changes over the past decades: (1) falling birth rates globally have seen the dependency ratio drop, (2) the integration of China and eastern Europe into the global economy has boosted the global workforce by 120%.


Coodhart and Pradhan then argue that these forces have seen:

A large increase in he global labour supply, which has resulted in a fall in the price of labour - wages.

This weighs on inflation; and Labour has become cheaper, relative to capital, and therefore businesses globally are less inclined to invest, reducing labour productivity.

Interest RatesThis also weighs on wages. Further, this results in a fall in the equilibrium interest rate, as firms need a lower interest rate to trigger investment.

As such, it is also harder for monetary policy to stimulate growth and inflation.

However, this demographic dividend has now ended.

The world now faces an aging population and rising dependency ratio.

Goodhart and Pradhan argue that this will cause savings to fall, relative to investment, lifting the equilibrium interest rate and inflation.

  • Savings will fall as the share of older people rises. The authors argue that this effect will not be offset by young workers saving more to fund their longer retirements as life expectancy rises. This is because, while the authors note a sharp rise in spending as people get older due to large health costs, they assume these health costs are paid by government. So private savings are unaffected, although taxes will increase.
  • Investment will not fall as much as savings. This is because residential construction will be supported by an older population that, all else equal, will have less people per household as the elderly are less likely to live with others or move in with their children. Separately, the authors argue that the smaller and more expensive labour force means corporates will shift more investment into capital.

A higher equilibrium interest rate should make it easier for monetary policymakers to stimulate inflation, reversing its multi-decade decline.

Importantly, Goodhart and Pradhan emphasise their theory is about global labour market dynamics.

Therefore, they push back on criticism that cites country- specific examples of aging populations and weak inflation, such as Japan.

Caveats - why the aging population may not boost the equilibrium interest rate and inflation

Goodhart and Pradhan acknowledge some key risks to their outlook:

  1. The degree of government social support could be reduced. That would mean savings rise as workers need to save more for their retirement, such that the aging population is disinflationary.
  2. The global labour force may be supported by other factors: (1) participation by older workers could rise further, (2) the rise of India and Africa could see another boom in the global labour force and activity.
  3. Large debt overhang could delay the transition. The authors state unprecedented indebtedness could take decades to unwind, where debt is weighing on real rates and inflation. It’s not clear how this interacts with their other arguments.

We agree that these are major challenges to the authors’ thesis, particularly their assumption that government social support remains unchanged.

UnemploymentFurther, even if social welfare for older people remains unchanged, we question whether workers are able to gain the pay rises needed to provide this support.

The growing health expenditure will need to be paid for, either through taxes or private savings (should the government support be reduced).

Much lies in Goodhart and Pradhan’s assumption that workers bargaining power will have increased due to slower growth in labour supply.

We question whether that will be the case, given we think other factors, such as globalization have also worked to flatten the Philips curve.

In a low growth enviroment, due to slow population growth that is not offset by large productivity gains, it may be hard for firms to lift pay rates, even if labour supply is growing more slowly.

Future discussion - peak globalisation?

Goodhart and Pradhan’s arguments are interesting, though we are yet to be convinced that an aging global population will see savings fall and inflation rise sharply.

Population AgeingPerhaps more evidence will be presented in their upcoming book.

As noted earlier, we think the near-term pressure of the demand shock and increased unemployment will be more important factors restraining inflation.

In our view, a potentially equally important discussion will be the impact of globalisation trends.

Some economists argue that supply chain integration has reached its peak, with this effect also a significant disinflationary force for decades.

We intend to revisit this topic in a future weekly, where we will also take a look at Australia’s exposure to global inflation factors.

Source: NAB Australian Market Weekly - this is not advice as it has been prepared without taking into account your objectives, financial circumstances or needs.

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About Michael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.

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