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Analysis: Ageing could weaken central banks, spur rate volatility

The Bank of England is seen in the City of London August 7, 2013. REUTERS/Toby Melville
The Bank of England is seen in the City of London August 7, 2013. REUTERS/Toby Melville

By Mike Dolan

LONDON (Reuters) - Not unlike the ageing public - central banks will have to work harder as their economies grey and greater interest rate volatility over time may well be the outcome.

Monetary policymakers around the globe are already preparing households and businesses for the likely end of the present super-low interest rate era over the years ahead.

Yet despite five years of crisis-management in which central banks were the dominant and most powerful forces, some economists reckon they have been steadily losing their influence on the real economy in recent decades.

The success of inflation targetting in managing long-term expectations has in itself lessened the reverberations of interest rate moves, as did developments in housing finance and extensive credit deregulation.

But one reason cited for central banks losing that traction is rapid ageing populations.

On the basic 'life-cycle' assumption that younger people incur more debt and older folk have higher savings and assets as they hit retirement, the argument centres on the idea that debtors rather than creditors are far more sensitive to interest rates.

As that plays out in aggregate - and the data suggests it has over recent decades - then the risk is central banks will have to pull much harder on the interest rate lever as populations age over time to make an impact on the real economy.

And given the level of anxiety in world markets about just the beginning of the end of almost five years of near-zero U.S. interest rates, the prospect of more strident rate moves when they happen is a potentially daunting prospect.

So does the demographic influence stack up?

In a working paper for the International Monetary Fund published this month, staff economist Patrick Imam modelled the impact of one percentage point moves on joblessness and inflation over 50 years in five countries - the United States, Britain, Canada, Germany and Japan.

The paper then mapped those changes against shifts in the old-age dependency ratios in each of the countries to focus on the extent to which ageing can explain at least some of the changes in interest rate sensitivity.

The study found there was a robust enough relationship to say demographic trends did contribute to the drop in monetary policy effectiveness and this opens up a number of policy implications.

The first is how the aversion to inflation among older savers and fixed income earners, compared to youngsters who may like to have their debts, tilts central banks' priorities toward keeping inflation and inflation targets low if ageing demographics hits economic activity over time.

The second is the scale of any rate moves that may be required to shift behaviour and prices in an economy increasingly dominated by its older citizenry.

"If monetary policy is less effective in a greying society, ceteris paribus, a larger change in the policy rate will be needed to bring about a change in the economy than in a younger society," Imam wrote. "This implies that traditional changes of 25 basis points, which have been the norm in previous decades, may have to be amplified."

Another conclusion is that governments may just have to look more at either fiscal and budgetary policies, regulatory measures or overt direction to steer their economies in a world increasingly desensitised to monetary tools.

FASTER AGEING

For all the questions that may raise, doubts about the rising age profile of economies is not one of them.

United Nations' projections for the developed economies have old-age dependency ratios, the share of retirees to workers, almost doubling to more than 40 percent over the next 30 years.

And a paper by Deutsche Bank this month reckoned even the UN forecasts underestimated the impact of falling fertility rates.

It concluded the human species will stop expanding as soon as 2055, half a century sooner that UN estimates, and ageing societies will be forced to respond by extending working lives.

The implication for monetary policy is more controversial and some experts see the IMF paper's data conclusions as too clean cut for all the complex and ambiguous influences at play.

George Magnus, economic adviser to UBS and author of 2008's 'The Age of Aging", says he's sceptical of the simplicity of the idea, not least given the gigantic hit savers have taken from zero rate policies and bond buying over the past five years.

Net interest income accruing to U.S. savers and assets holders has dropped by the equivalent of 4 percent of U.S. gross domestic product over that period, he estimated - a figure equivalent to the entire U.S. fiscal stimulus of 2009/10.

Whether it's the scale of private sector debt paydown seen in recent years or the sort de-risking behaviour forced on pension funds by slashing their discount rates, Magnus reckons there have been just too many other reasons and influences surrounding the ebbing force of monetary policy of late.

"The ageing impact on monetary policy is curious long term but the exercise seems little other-worldly right now," said Magnus. "Maybe in 10-15 years this may well be more obvious but it's hard to disentangle it quite so simply today."

(Editing by Ron Askew)

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