One of the great frustrations of the last few years has been that, even as central banks around the world have taken extensive steps to try to prop up growth, the impact hasn't been that great. Indeed, over the last generation, there's lots of evidence that changes in interest rates don't pack the punch, in terms of both jobs and inflation, that they used to.
A researcher at the International Monetary Fund has a novel explanation for one reason why this may be: namely, a growing proportion of the world population, and especially in advanced nations, that is elderly.
"We will argue that monetary policy also has a weakened effect on the economy due to changing demographics," Patrick Imam writes in a working paper. "The elderly used
to account for a small share of the population, but technological breakthroughs and social
changes over the last two centuries have transformed this demographic structure."
What's the theory? To start with, monetary policy works by changing the cost of borrowed money. When growth is weak, a central bank cuts interest rates, which in turn makes spending, consumption, and investment more attractive. You're more likely to buy a house or a car if the interest rate is 3 percent than if it's 5 percent, for example. But crucially, the use of borrowed money is a crucial way that these lower rates translate into higher economic growth.
But borrowing money is disproportionately an activity of the young. Economists call it "life cycle hypothesis of saving" -- people use credit to smooth out what they can consume over the course of their lives. When just embarking on a career, a young person might take out major loans for education and for buying a house and car. As they reach middle age, they will tend to have paid down some of that debt while also building savings. By the time they hit retirement age, they should be net creditors, with significantly more savings than they still owe in debt.
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.
Writes Imam: "These estimates thus imply, when taken at face value, quite a strong negative long-run effect of the ageing of the population on the effectiveness of monetary policy. This is particularly significant when linked to, for instance, the projected 10-point rise in the old-age dependency ratio in Germany over the next decade."
For the last five years, in a time of zero interest rates, Fed chief Ben Bernanke and the rest of the Federal Reserve have been scratching their heads trying to figure out how to get more juice out of their interest rate policies in terms of economic growth. If Imam's research holds up to scrutiny, it suggests what they're fighting isn't just the normal problems of an economy following a financial crisis, but a longer-term problem in which demographics will make the tools they have less powerful.