Why has recent macro-policy not been that effective? A demographic view

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1 Economics Research Why has recent macro-policy not been that effective? A demographic view Global Demographics & Pensions Research Research Analysts Amlan Roy amlan.roy@credit-suisse.com Anais Boussie anais.boussie@credit-suisse.com Mengyuan Yuan mengyuan.yuan@credit-suisse.com We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature. Nobel laureates George A Akerlof & Robert J Shiller in Animal Spirits (2009). Advanced country demographics have been changing at an unprecedented rate, some of these changes over the last years have historically taken centuries. These changes have been ignored by policy makers and investors who assume that they are slow-moving, long-term and predictable. The focus on number of people and age when thinking of demographics is misleading, instead the focus should also be on the behaviour of consumers and workers and their associated distributions. Over , the population share of the 80+ age group increased by 771% (Japan) and 103% (the US). Public expenditures on account of ageing (20.2% of GDP in 2010 for EU27) create a fiscal drag on growth prospects and the fiscal strains necessitate renegotiation of past promises. Over , the G6 (US, UK, France, Italy, Germany & Japan) male labour force participation rate for the age group increased from 63% to 68% but for the age group decreased from 60% to 47%. Persistent youth unemployment of 40% (Italy) and 24% (France) in 2013 has been and continues to be a drag on growth and public finances. In 2013, males earned 51% more than women in the US, 132% more in Japan and 55% more in the UK. The wealth share of the top decile was very high: 75% (US), 54% (UK) and 53% (France) for Monetary policy has multiple and changing objectives but few instruments to tackle these objectives. Its impact is very mute and relatively ineffective based on conventional policy instruments as they do not take the age structure and changing behaviour of consumers and workers into account. Voting patterns of the old impart a disinflationary bias in their favour. Fiscal policy needs to be more targeted in terms of its actions through both government expenditures as well as taxation. The policies need to target differently the young vs. old, the skilled vs. the unskilled, the rich vs. the poor, etc. Effective redistribution will be the key in a demographically changing world facing low growth prospects. Updated conventional macro-policy tool-kits and models which guide policy makers ought to appropriately incorporate the changing demographics and the changing distributions. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 Recent macro policy ineffectiveness: A demographic view The aftermath of the credit crisis over last six years or more has been characterized by low growth, high unemployment, high youth unemployment and low/negative real interest rates in the developed world. A possible reason for this is that macro policy-making (both monetary and fiscal policy) in the post-lehman crisis era has not been very effective. We argue that governments and central banks did not appropriately account for the changing and heterogeneous demographics in their policy-making, thus making policy less effective. In this report, we provide evidence of the very dramatic and unprecedented demographic changes that have been unfolding over the last couple of decades. Yet these changes have been dismissed by policy makers and investors as slow-moving, predictable and long-term. We criticize such views and opinions by viewing them as being dated. We document the macro (fiscal and monetary) policy actions post the credit crisis arguing that they were inadequate in targeting consumers and workers in a changing world. Demographics is about workers who make the GDP and consumers who consume the bulk of the GDP. They are the foundation of the macro economy. For policies to be effective, they need to be targeted by taking into account the changing behaviours of consumers and workers and not focusing only on numbers of people or age. This report is structured as follows. In the first section we present how countries are facing unprecedented demographic changes. In the second section, we focus on differences amongst the current workers and consumers as well as on how they have changed over the years. In the third section, we describe the current demographic and macroeconomic environment. In the fourth section, we discuss the role and effectiveness of monetary policy in an ageing world and how demographics should be taken into account when designing monetary policy. And finally, we emphasize why and how fiscal policy needs to be appropriately targeted at consumers and workers in order to be effective. Unprecedented demographics changes The G6 countries (France, Germany, Italy, Japan, the UK and the US) have seen unprecedented changes in demographics. Exhibit 1 displays population growth rates over the period (projected) in the G6 countries. Exhibit 1: Population growth rate in G6 countries Rate per annum Exhibit 2: Total fertility rate in G6 countries Children per women Source: UN, Credit Suisse Source: UN, Credit Suisse Why has recent macro-policy not been that effective? A demographic view 2

3 Exhibit 3: Life expectancy at birth in G6 countries The US population is expected to grow at the fastest rate of 3.8% per annum in the population of the UK and France are also expected to grow positively in this period. This is in contrast with Germany, Japan and Italy which are projected to experience negative population growth rates. These differences in population growth rates can partly be explained by lower and declining fertility rates in Italy, Germany and Japan relative to France, the UK, and the US. Exhibit 2 displays the change in total fertility rates of the G6 countries from the 1980s to the 2000s. 1 Exhibit 4: Old-age dependency ratio in G6 countries Years Population aged 65+ per 100 population aged Source: UN, Credit Suisse Source: UN, Credit Suisse Women are also giving birth to babies later. In the 1980s, the age group had the highest fertility rate whereas in the 2000s, women aged had the highest fertility rates. This can be seen by examining the age specific fertility rates for the G6 countries in Exhibit 28 in the Appendix. Another unprecedented demographic change is that people are living a lot longer as well. Exhibit 3 shows the life expectancy at birth for G6 countries has increased and the increases range from 8% to 13%. Life expectancy in 2015 is 83.5 years in Japan, 82.3 years in Italy and 81.7 years in France. Increased life expectancy, combined with low fertility rates, has led to higher old-age dependency ratios. This means a greater burden on the young workers to support the older-aged population. Exhibit 4 presents the increasing old-age dependency ratio (number of old aged persons per 100 of working age ) over 1980 to 2015 for the G6 countries in the UK, the ratio increased from 23 to 27 whereas Japan has seen the most significant rise in its old-age dependency ratio from 12 to 44. Exhibit 5 and Exhibit 6 highlight the change in the population shares of the 60+ and the 80+ age groups. Over , the share of the 60+ age group increased in Japan, Italy, and the US by 287%, 109%, and 73%, respectively whereas the share of the 80+ age group increased in Japan, the UK and the US by 771%, 116%, and 103%, respectively. 1 None of these countries currently has a fertility rate above replacement rate (2.1 children per woman of child-bearing age). Why has recent macro-policy not been that effective? A demographic view 3

4 Exhibit 5: Share of 60+ age group: 1970 & 2015 Exhibit 6: Share of 80+ age group: 1970 & 2015 Percentage of total population Percentage of total population Source: UN, Credit Suisse Source: UN, Credit Suisse Workers and consumers Demographics is about workers and consumers. Workers produce the aggregate GDP whereas consumers consume the bulk of the GDP. Consumer sentiment and worker psychology are important and not exogenous. Demographic characteristics play an important role in influencing behaviour. George Akerlof and Robert Shiller (2009) in Animal Spirits state that human psychology drives the economy and explain why it matters for capitalism. In order to implement effective monetary and fiscal policies, governments need to take into account the heterogeneity across workers and consumers and incorporate their endogenous behavioral responses. In this section we will focus on understanding the changing characteristics of workers and consumers. How have the workers changed 2? Workers exhibit different patterns of behaviour based on characteristics such as gender, age, education, skills, nativity, etc. Exhibit 7 displays the gender and age-specific activity rates over showing that female labor force activity rates have increased but still exhibit a large gap to males especially at older ages. Prime working age (i.e ) male labour force participation rates have decreased in all G6 countries. In contrast, the age group has seen an increase in the labor force participation rates for both male and female. The marked decrease in economic activity rates for the younger age groups reflects youth unemployment as well as the increased skills requirements for the young. The labour force participation rates of males aged has decreased from 75.3% in 1985 to 60.7% in 2013 in the UK, from 53.2% to 30.8% in Italy and from 55.3% to 40.9% in France. In order to implement efficient policies to boost growth it is necessary to understand the age structure of the labour force, their differential education and skill levels across countries as well as the underlying country demographics. Policies need to be targeted taking into account the behavioural differences across the age structure of the workers. However, past research papers on the age structure have not adequately considered the changing behavior of different age groups of workers. 2 Credit Suisse Demographics Research (2000) "The Demographic Manifesto-New Jobs, New People" Why has recent macro-policy not been that effective? A demographic view 4

5 Exhibit 7: Labour force participation rates by gender, G6 Percentage France Germany Italy Male Female Male Female Male Female Male Female Male Female Male Female Japan UK US Male Female Male Female Male Female Male Female Male Female Male Female Source: ILO, Credit Suisse Exhibit 7 also illustrates the differential impact of policies on the participation rates of the old-age labour force (65+) groups. The 65+ age group labour participation rates over have exhibited different patterns with increases in the UK, the US, Germany but decreases in France, Italy and Japan partly owing to different worker incentives at different ages. Labour force participation rates of the older Japanese are much higher than those of their counterparts in the other G6 countries 3 and this is a consequence of the institutional structure and arrangements. High unemployment rates since the 2008 financial crisis have dragged down growth and increased the fiscal burden on governments. Today youth is a particularly vulnerable group. Not only do they have a higher unemployment rate compared to the rest of the population, but they are also more adversely affected when economies suffer cyclical downturns or crises. Exhibit 8 shows that in all G6 countries, the youth unemployment rate is higher than the general unemployment rate. Since 2006, the increase in the youth unemployment rate in the hardest hit countries such as Italy, Greece, Ireland and Spain has seen an average 27 percentage point increase while the general unemployment rate increased on average by 12 percentage points as shown in Exhibit 9. Rising youth unemployment has a detrimental effect on economic growth, political and social stability as well as on the country s ability to exploit its potential demographic dividend. 3 We highlighted this in detail in Credit Suisse Demographics Research (2011), Macro Fiscal Sustainability to Micro Economic Conditions of the Old in the Oldest Five Countries Why has recent macro-policy not been that effective? A demographic view 5

6 Exhibit 8: Youth unemployment vs. general unemployment, 2013 Exhibit 9: Change in unemployment rate, Percentage Change in percentage point Source: OECD, Credit Suisse Source: OECD, Credit Suisse The dynamics of youth unemployment are important for both policymakers and markets to follow from an economic, societal and political perspective. The employed young consume differently than the older age groups whereas the unemployed young consume and save even more differently than the typical older employed age groups. How have consumers changed? Exhibit 10 displays the changing consumer expenditure patterns by age showing that there has been a dramatic shift in the consumption expenditure shares towards older age groups. Consumption expenditure shares for the 50+ age group accounts for 58.1% of total consumption in Japan, 54.2% in the US and 59.6% in Germany. This contradicts the common perception that the old do not spend. The old are wealthier than what most economists and policy makers anticipated them to be and are spending differently than what they were expected to. Exhibit 10: Changing age-specific consumer expenditure shares: 2005 and 2013 Source: Euromonitor, Credit Suisse Japan USA Germany UK Under % 0.4% 0.2% 0.2% 0.3% 0.3% 0.2% 0.2% % 6.3% 9.2% 8.7% 10.9% 9.9% 9.4% 11.0% % 14.8% 19.1% 17.3% 15.3% 11.5% 24.4% 20.7% % 20.1% 23.6% 19.7% 19.8% 18.7% 24.6% 25.3% % 18.1% 20.5% 21.7% 19.9% 23.4% 20.3% 19.7% % 40.3% 27.4% 32.5% 33.9% 36.2% 21.1% 23.1% Given their different spending behavior and level of wealth, people of different age groups have different credit demands and also responds to interest rate changes differently. Exhibit 11 shows the debt of different age groups and Exhibit 12 shows the median value of real assets held by different age groups for the euro area. We note that the older people have less debt and more assets relative to their debt in general. Why has recent macro-policy not been that effective? A demographic view 6

7 Exhibit 11: Participation in debt by age group, euro area, 2013 Exhibit 12: Financial position by age group, euro area, 2013 % Debt-Asset Ratio Net Liquid Assets-Income ratio Source: ECB, Credit Suisse Source: ECB, Credit Suisse Monetary policy in an ageing world needs to be very different, as older people respond differently to the interest rate than younger people. Hence monetary policy models need to incorporate age distribution of consumers. In addition, fiscal policy needs to target inequalities as they are detrimental for growth, lead to foregone consumption and threaten social stability. When examining data on Gross National Income (GNI) per capita by gender in Exhibit 13 we see that men on average earned 51% more than women in the US, 132% more in Japan and 55% more in the UK. Men and women also consume very differently and this gap in gross national income leads to a loss in consumption for women. Exhibit 14 presents the trends in the wealth share of the top decile % of the wealth is held by the top decile in the US, 54.1% in the UK and 53.1% in France. Exhibit 13: GNI per capita, by gender, 2011 USD 70,000 60,000 50,000 40,000 30,000 20,000 Exhibit 14: Trends in wealth share of the top decile Percentage ,000 US Germany UK Japan France Italy Female Male 40 UK US Italy Germany Japan France Source: UNDP, Credit Suisse Source: Credit Suisse Having such high shares of wealth concentrated in the top decile arguably leads to a lower aggregate consumption as wealthier people consume a smaller proportion of their income compared to poorer people. Therefore it is important to have an effective redistributive fiscal policy in order to boost consumption. 4 We discussed this in detail in Credit Suisse Demographics Research (2011), Macro Fiscal Sustainability to Micro Economic Conditions of the Old in the Oldest Five Countries Why has recent macro-policy not been that effective? A demographic view 7

8 Demographics and the macroeconomic environment Low inflation Exhibit 15: Voting patterns, old vs. young, 2011 Population aging could affect inflation through various channels. If the old consume less than the young, ageing will exert a downward pressure on aggregate demand and hence reduce inflation. At the same time, it decreases labour supply which makes inflation higher. According to Bullard et al (2012), when the old have more influence on the redistributive policy, the economy will have a relatively low rate of inflation. This is because older people have more assets; they prefer low inflation as inflation tends to decrease asset value and real rate of return. Relatively, young cohorts have fewer assets, their main source of income is wages which rise with inflation; the young thus prefer high inflation. Exhibit 15 shows the difference in political participation across different age groups. Older people are more likely to vote and participate in the political process, thus they are more likely to exert influence over policy making both monetary and fiscal. Exhibit 16 shows the inflation rate and demographics of Japan. As the population grew older (smaller share of population aged 20-44), inflation rates plummeted. Bullard et al (2012) suggest that aging population structures may contribute to the observed low level of inflation or even deflation. Yoon, et.al (2014) from the IMF also provide support for the above finding that conditional on a given growth rate, the aging process will suppress inflation significantly. Exhibit 16: Inflation and demographics, Japan Percentage point difference in voting rates between 55+ and yrs. old Percentage Percentage of Population yrs. old CPI Inflation (LHS) 2 per. Mov. Avg. (Youthful population (RHS)) Source: OECD Source: UN, Thomson Reuters Datastream, Credit Suisse High youth unemployment 5 In previous Credit Suisse research 6, we showed that youth unemployment has become a global phenomenon today with 74.6 million young people unemployed in Young people are three times more likely to be unemployed than adults. They are also the group that was hit the hardest by the financial crisis as mentioned earlier. Many found themselves in temporary jobs without job security. This has important implications for policymakers since it affects countries political stability as well as growth potential. An ageing population has two opposing effects on youth unemployment. When there are relatively fewer young people (due to lower fertility rates) competing for jobs, it decreases youth unemployment. On the other hand, as older people choose to work for longer, it potentially displaces some of the younger workers, thus increasing youth unemployment. The overall impact depends on the relative magnitude of these two effects. 5 International Labour Organisation (2013), Global Employment Trends for Youth 2013, A Generation at Risk 6 Credit Suisse Demographics Research (2013), Rising youth unemployment: A threat to growth and stability Why has recent macro-policy not been that effective? A demographic view 8

9 Ongoing technological development has further exacerbated the youth unemployment problems. The young in the advanced economies are losing jobs to both machines/robots and cheaper work forces in poorer countries. Policies that better prepare the young in the changing macro-economic environment are essential. Monetary policy in an ageing world The effectiveness of current monetary policy In response to the crisis, central banks across the advanced economies have been using both conventional and unconventional monetary measures aggressively. Exhibit 17 shows the key central bank interest rates. Since mid-2009, they have been lowered by the central banks to near or even below zero in an attempt to stimulate consumption and business investment post the credit crises and the crises of the peripheral southern European countries. Influencing short-term interest rates has worked well in the past within a stable banking and economic environment but has not had the same desired effect recently. When market and banking system stability has been threatened - as in this current crisis - central banks have attempted to restore market functioning through unconventional monetary policies. These include policies such as liquidity and credit facilities ensuring the smooth functioning of the market as well as encouraging bank lending. Other unconventional monetary policies also include forward guidance and asset purchase programmes, i.e. quantitative easing. To date, the Bank of England has purchased 375 billion of assets under its Asset Purchase Programme. Japan has also recently expanded its quantitative easing programme. As a result, balance sheets of most advanced country central banks have increased dramatically. Exhibit 17: Central bank interest rates Percentage Exhibit 18: Inflation rates, G6 Percentage US EU Japan UK Source: National sources, Credit Suisse France Germany Italy Japan UK US Source: International Monetary Fund, Credit Suisse It is hard to assess the counterfactuals, thus it is difficult to tell exactly how effective these programmes have been. Many research papers find that bond purchases help increase growth by about 2 percentage points in the US and UK, while inflation could increase by 3.6 percentage points. However, both results range widely from one research source to another 7. 7 IMF Policy Paper (Sep 2013), Global Impact and Challenges of Unconventional Monetary Policies Why has recent macro-policy not been that effective? A demographic view 9

10 Examining macroeconomic indicators, we find that the effects have been varied and limited. Monetary policies in place may have prevented a deeper recession, but their effects on generating a renewed growth and stable inflation environment have been relatively muted. We believe that demographic dynamics reflected in consumer and worker characteristics and their distributions have been largely neglected or ignored in most macro-policy deliberations. Exhibit 18 shows the inflation rate for the G6 countries since While the US and Japan are seeing their inflation rates pick up slightly, most of the countries are seeing disinflationary effects from In fact, countries in the euro zone are now facing a nonnegligible risk of deflation. Exhibit 19 and Exhibit 20 indicate the growth of business credit and consumer credit in the US and Europe respectively. The US after experiencing a sharp contraction of business and consumer credit since the Lehman bankruptcy, has since recovered and started to see both consumer and business credit grow. In the euro area, despite the negative interest rates adopted by the ECB, the response from both business and consumers is more muted neither of them are seeing positive growth recently. Exhibit 19: Business credit and consumer credit growth, year-on-year, US Percentage Exhibit 20: Business credit and consumer credit growth, year-on-year, euro area Percentage Federal Funds Effective Rates Consumer Credit Business Credit ECB Basic rates Consumer credit Business credit Source: Thomson Reuters Datastream, Federal Reserve, Credit Suisse Source: European Central Bank, Credit Suisse Interest rate as a monetary policy tool and ageing population There are many channels through which an ageing society may affect the effectiveness of monetary policy. First, it is through the interest rate and credit channels. As mentioned earlier, older people tend to hold more assets and have less need to borrow. They can usually self-finance their consumption and investment, hence rely less on external finance. This makes them less sensitive to interest rate changes, thus this decreases the effectiveness of monetary policy. On the other hand, as old people tend to hold more interest rate-sensitive assets, interest rate changes may have a more significant impact on their wealth, which should make monetary policy more effective. How an ageing population affects monetary policy depends on the relative size of the credit and wealth effects. Patrick Imam (2013) from the IMF showed that the old-age dependency rate has a statistically significant negative long-term impact on the effectiveness of a country s monetary policy. As Imam states and we concur too with his view--this aging shift has several potential implications and lessons for policy makers. Monetary policy has to be more aggressive. In an ageing society, a greater change in policy rates is needed to elicit the same level of response. However, given the current low interest rates across all advanced economies, there is very limited scope for aggressive monetary policies. Why has recent macro-policy not been that effective? A demographic view 10

11 Questioning the inflation targets of monetary policy. All the major central banks (i.e. the Fed, BoE, BoJ, and the ECB) today have an inflation target at 2%. This 2% target has successfully brought down the inflation level from more than 10% in the 1970s and stabilized the price level in the recent decades. However, given the disinflationary environment and smaller growth potential created by changing demographics, the current low level of the inflation target is harder to justify. In times such as today s recession, a higher inflation target would have allowed the central banks to cut the nominal interest rate by more. Monetary policy models and frameworks. The new generation of monetary models still falls short of incorporating demographic-related distributional and behavioural changes exhibited by consumers and workers. As a result of this, in an inter-connected real and financial world, the transmission mechanisms and dynamics are very different than those understood and modeled. The Taylor rule developed by John Taylor and applied by many others is based on forward looking households and firms in decision making and expectation formation. However it did not consider the changing demographics which affects behaviour broadly that encompasses both how decisions are made and expectations are formed. Also, Lipsky argues that Taylor rule applications in the 1990s were made in a conducive environment of productivity gains due to international trade and financial flows. As the unprecedented demographic change is affecting the external balance of countries through its effects on savings, investment and growth 8, monetary policy and Taylor rule applications will be more challenging in the face of exchange-rate and trade imbalances current and future. Recent research by monetary economists is insightful and encouraging in drawing links between ageing and house prices as well as money demand. To the extent that house values are part of wealth and influence the wealth distributions, it is necessary to understand these dynamic linkages 9. We believe that the current crisis has been misdiagnosed as a Great Recession without fully understanding that its origins lay in a housing and credit bubble created by consumers responding to easy credit. This misdiagnosis distracted the policy makers from tackling the structural effects associated with housing and the credit-related crisis. Few monetary models have in the past modeled credit, liquidity and housing effects associated with the crisis that policy should counteract. Other issues relating to ineffectiveness of current policy have to do with the differences between monetary theory and central banking practice 10 and the impairment of the transmission mechanism during a financial crisis 11. Other policy measures are needed to effectively stabilize the economy. While monetary policy has been, and is continuing to be, an important tool in managing inflation expectations and ensuring smooth credit and financial market operations, sound fiscal policies as well as macro-prudential policies are set to gain more importance in the macroeconomic policy tool set. 8 See Credit Suisse Demographics Research reports "Demographics, Capital Flows & Exchange Rates (2007)" and "Demographics, Japanese Current Account & a Disappearing Savings Rate (2009)" 9 K.G. Nishimura and E Takads (2012), Ageing, property prices and money demand, BIS Working paper John Crow, "Putting Central Banks in Their Place", in Leijonhufvud ed. "Monetary Theory and Policy Experience (2001)" 11 See discussion by M.L.Bech, L Gambacorta and E Kharroubi (2012) & by S. Claessens, M.A. Kose and M.E. Terrones (2008 & 2011) Why has recent macro-policy not been that effective? A demographic view 11

12 Towards a more targeted fiscal policy Fiscal policy Fiscal policy is the use of government revenues and expenditures to influence the economy, it is typically used to promote strong and sustainable growth, reduce inequalities and create fiscal sustainability. Since the recent financial crisis which threatened a worldwide recession, many countries turned to a more active fiscal policy due to widespread credit constraints 12. In the short term, fiscal policy targets economic stabilization depending on country circumstances. During a recession governments may try to stimulate the economy through expansionary fiscal policy. By contrast, in times of high inflation and high debt governments may use contractionary fiscal policy. In the long term, the aim is to reach sustainable growth and reduce inequalities by improving, for example, infrastructure or education. According to a country development level the goals and tools to reach sustainable growth will vary 13. Alberto F. Alesina and S. Ardagna (2009) examined large changes in fiscal policy in OECD countries from 1970 to Using simple regression their results shows that in the case of fiscal stimulus, tax cuts are more likely to increase growth than those based upon spending increases. And in the case of fiscal adjustment, spending cuts without tax increases are more likely to reduce deficits and debt over GDP ratios than tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. Fiscal sustainability The scope of effective fiscal policy response depends on a country s fiscal sustainability 14. Fiscal deficits and public debt ratios have expanded due to the 2008 financial crisis which has created concerns on the financial health of governments. Across all G6 countries government debts have reached unprecedented levels. Exhibit 21 displays the gross government debt for the G6 countries from 1991 to Japan has the biggest debt; it represents 237% of its GDP in 2013, followed by Italy with 127% and the US with 92%. In a recent Geneva Association & CEPR Report (2014) Deleveraging? What Deleveraging? 15 in assessing leverage across both public and private sectors, the authors find no evidence of aggregate deleveraging and highlight that leverage as well as debt dynamics affect growth. They assert that deleveraging and slower nominal growth interact in a vicious cycle. High debt burdens in the absence of good GDP growth lead to fiscal unsustainability. In order for the debt to be sustainable the growth rate of each country needs to be higher than the interest rate paid on the debt. Today, the ageing population in G6 countries combined with the economic slowdown presents real challenges for the sustainability of public finances. Many OECD countries have implemented or announced fiscal consolidation plans. The size and composition of OECD countries fiscal consolidation plans varies from one country to another. Exhibit 22 shows the expenditure and revenue based fiscal consolidation as percentage of GDP. Greece, Ireland and Portugal have announced large fiscal consolidation plans, of which approximately two thirds are structured around expenditure measures and the remaining one-third around revenue measures. 12 M. Horton and A. El-Ganainy (2012), Fiscal Policy: Taking and Giving Away, Finance & Development, IMF 13 W. Easterly and S. Rebelo (1993), Fiscal policy and economic growth, Journal of Monetary Economics, Volume 32, Issue 3, Page Craig Burnside (2005), Fiscal sustainability in Theory and Practice, The World Bank 15 L.Buttiglione, P.R. Lane, L Reichlin and V. Reinhart (2014), Deleveraging? What Deleveraging? Geneva Reports on the World Economy 16", ICMB & CEPR. Why has recent macro-policy not been that effective? A demographic view 12

13 Exhibit 21: Gross government debt % of GDP % of GDP Exhibit 22: Expenditure and revenue based fiscal consolidation as percentage of GDP ( ) Source: IMF, Credit Suisse Source: OECD, Credit Suisse Fiscal consolidation plans should consider the costs associated with demographic changes, as most of the OECD countries are facing budgetary pressures due to an ageing population. High debt burden combined with fiscal deficits leads to a limited scope for fiscal policy. Hence we believe that fiscal policy should be targeted towards both workers and consumers which create and consume GDP. On average ageing-related public spending is expected to increase by nearly 3% of GDP between 2014 and 2030 according to the OECD 16. Growth decomposition GDP growth can be explained by three demographic drivers as per a framework developed by the ECB and used by us in many previous reports 17 : (i) Working age population growth (population aged years) (ii) Labour productivity growth (real GDP/hours worked) (iii) Labour utilization growth (hours worked/working-age population) Working-age population growth: Exhibit 23 displays the growth in working-age population (15-64 years old). Across all countries the working-age population has decreased. The size of the working-age population depends on fertility rates and net migration rates. We have seen in section 1 that the US, UK and France had increasing fertility rates compare to the 1980s and these three countries have the lowest decrease in working-age population of the G6 countries. Exhibit 24 presents net migration rates which show that the G6 countries exhibit significant differences in their migration patterns. In Japan and Germany net migration is projected to be very low in the coming years which is going to be a real problem for them as they have the lowest working-age population growth rate in the G6. 16 OECD (2013), Government at a Glance 2013, Fiscal sustainability 17 Credit Suisse Demographics Research (2009), A Demographic Perspective of Economic Growth Why has recent macro-policy not been that effective? A demographic view 13

14 Exhibit 23: Working-age population growth rates % Per 1,000 population Exhibit 24: Net migration rate Source: UN, Credit Suisse Source: Credit Suisse Another reason that can partly explain this decrease in working-age population is the exit of baby boomers from the labour market. As we have seen in section 1 in all the G6 countries population ageing translates into a higher old-age dependency ratio that creates fiscal unsustainability pressures. Hence there is a crucial need for fiscal policy to be targeted toward workers. Labour productivity growth Exhibit 25 displays labour productivity growth from 1951 to Labour productivity is calculated by using real GDP divided by total hours worked. All the G6 countries have seen their productivity growth rates decrease since We have previously analyzed the reasons of this decline in a report called A Demographic View: Do not write off US GDP growth, (2014). Exhibit 25: Labour productivity growth Labour productivity in % calculated as real GDP/total hours worked Source: The conference Board, Credit Suisse Why has recent macro-policy not been that effective? A demographic view 14

15 Labour utilization growth Labour utilization growth is calculated as total hours worked divided by working age population. Exhibit 26 displays labour utilization of the G6 countries from 1960 to We can see that for all countries, labour utilization is declining overall. Exhibit 27 presents labour utilization growth of the G6 countries from 1960 to We can see that most countries have been experiencing negative growth since 1960 except for Germany and the US. Since 2008 we observe negative labour utilization growth for all countries. Exhibit 26: Labour Utilization, G6 Total hours worked/working age population Exhibit 27: Labour Utilization Growth, G6 Growth rate in % per annum Source: The conference Board, Credit Suisse Source: The conference Board, Credit Suisse Labour utilization reflects the growth in hours worked which depends on hourly wages, work-leisure tradeoffs and the disutility from additional hours worked beyond a limit due to diminishing marginal productivity and physical tolerances. At lower income levels, increases in hours worked generate greater utility based on higher labour income whereas beyond a threshold of income and wealth, the overall hours decision depends on the relative strengths of the income vs. the substitution effect. Postrecession or after being laid off, many workers try to do multiple jobs to trade off job security and multiple sources of income as a diversifier 18. A.Alesina and F.Giavazzi ed. (2013) comprehensively address the issue of whether researchers and practitioners of fiscal policy have come a bit closer (post the crisis) in bridging their ideological differences in Fiscal Policy after the Financial Crisis. They recognise that fiscal policy is more politicised than monetary policy discussing the issues of discretionary countercyclical fiscal policy, long-term debt, deficit reduction plans and politics and institutions. This series of chapters in the book by fiscal experts provides credence to the major point of our report that demographics needs to be better incorporated into fiscal policy if it has to be more effective. Targeted fiscal policy 19 Workers To deal with a declining working-age population fiscal policy needs to be targeted. It needs to incorporate potential new sources of labour: - Young workers need to be incorporated into the job market. This can be done through many channels such as i) incentivizing the public and private sector to create jobs and opportunities for young people ii) preparing young people for the labour market through an efficient education system iii) and creating a welfare system which gives greater support to unemployed young people. 18 Credit Suisse Demographics Research (2014), A demographic View: Do not write off US GDP growth 19 IMF Policy Paper (Jan 2014), Fiscal policy and income inequality Why has recent macro-policy not been that effective? A demographic view 15

16 - Older workers, ought to be allowed opportunities for part-time and flexible work as advocated in our previous research which suggested solutions 20 for ageing countries facing the demographics 'time-bomb'. Older workers have a wealth of industry and company experience that may be leveraged if it makes sense from both an employer and employee perspective. This not only allows the possibility of decreasing the effective old-age dependency ratio but may help older people to potentially avoid or postpone diseases such as Parkinson s or Alzheimer s as staying mentally active helps support brain activity and increases physical activity as well as agility. - Female workers need to be better incorporated into the job market and for this governments need to create a system which allows women to better combine a private and professional life. In Japan for instance there is no effective maternity benefit system in place. In the US, women after giving birth are allowed just 12 weeks of unpaid leave which can prevent women from going back to their work life. In France, on the contrary, any women giving birth is allowed one year of paid leave which can partly explain why France is one of the G6 countries with the highest female labour force participation. - Immigration needs to be selective and enhanced. Countries with low fertility rates need to promote immigration as it is a huge potential source for the labour force. - Increase productivity and labour utilization through better education programmes, training and higher investment in research and development. One of the conclusions in the chapter by Valerie Ramey is that private unemployment does not respond to government stimulus packages with virtually all employment increases coming from government hiring. Also, a common finding is that there is no such thing as a single fiscal multiplier and that fiscal policy effects are heterogeneous across countries and that fiscal policy is expected to be more effective close to the zero lower bound when monetary policy cannot work that well. Fiscal policy delegation and implementation is also more political due to its redistribution effects. The challenge as acknowledged by researchers is which rules should governments adopt in order for fiscal policy to not be influenced by day-to-day politics. Consumers We have previously discussed how to boost GDP from the supply side. Now we will focus on the demand side. In order to boost consumption governments need to put into place efficient redistributive policies to target inequalities, in our view. This is because the poor have a much higher marginal propensity to consume. While studies have shown that income taxes and higher spending on social benefits are the best tools to reduce inequality, we also have to ensure that redistributive policies do not discourage work and are in line with government fiscal consolidation efforts. In section 1 we also showed that the gap in wages between men and women is very significant which represents foregone consumption. We believe such inequalities must be reduced to allow consumers to reach their full consumption power. 20 Credit Suisse Demographics Research (2000) "The Demographic Manifesto-New Jobs, New People" advocated radical solutions for the ageing problems faced by advanced economies. Why has recent macro-policy not been that effective? A demographic view 16

17 Conclusions This report presents a demographic view on why macro-policy has not been that effective. The crux of the argument relies on showing that demographic changes which are historically unprecedented have been ignored or neglected by macro-policy makers. The ineffectiveness of recent macro (monetary and fiscal policy) is evidenced by the fact that the post-lehman crisis recovery has been very slow, partial and has not created conditions to affect expectations positively. We demonstrate changing characteristics of consumers and workers highlighting that these need to be accounted for in terms of changing work patterns, consumption patterns, wealth and debt patterns as well as the endogenous behaviour across income distributions, wealth distributions, age distributions and also across countries. Macroeconomic models and technical toolkits which have guided macro policy-making have neglected the distributional and demographic dynamics of consumers and workers. Assumptions of homogeneity and representative agent paradigms have fallen short of capturing the changing behaviour of consumers and workers, which are influenced by their demographic characteristics. A better understanding of the changing demographics should also help guide models (both fiscal and monetary) that guide policy. We provide a few examples of very technical and advanced models used in state-of-art monetary and fiscal economics yet miss out on incorporating appropriately the changing demographic distributions. Why has recent macro-policy not been that effective? A demographic view 17

18 References G. Akerlof and R. J. Shiller (2009), Animal Spirits, Princeton University Press A. Alesina and F. Giavazzi ed (2013), Fiscal Policy after the Financial Crisis, NBER Conference report by University of Chicago Press. A. F. Alesina and S. Ardagna (2009), Large Changes in Fiscal Policy: Taxes Versus Spending, In Jeffrey R. Brown. Ed. Tax Policy and the Economy, Volume 24, The University Chicago Press, p C. Bean (2004), Global Demographic Change: Some Implications for Central Banks, Speech script at the FRB Kansas City Annual Symposium, Jackson Hole, Wyoming M.L. Bech, L. Gambacorta and E. Kharroubi (2012), Monetary policy in a downturn: Are financial crises special?, BIS Working Papers 388. J Bullard, C Garriga, and C J. Waller (2012), Demographics, Optimal Redistribution and Inflation, Federal Reserve Bank of St Louis REVIEW Craig Burnside (2005), Fiscal sustainability in Theory and Practice, The World Bank L. Buttiglione, P.R. Lane, L Reichlin and V. Reinhart (2014), Deleveraging? What Deleveraging? Geneva Reports on the World Economy 16, ICMB & CEPR. S. Claessens, M. A. Kose and M. E. Terrones (2008), What Happens During Recessions, Crunches and Busts? IMF Working Paper/08/274. S. Claessens, M. A. Kose and M. E. Terrones (2011), Financial Cycles: What? How? When? IMF Working Paper/11/76. Credit Suisse Demographics Research (2014), A demographic View: Do not write off US GDP growth Credit Suisse Demographics Research (2013), Demographic dynamics over business cycles and crises: What matters is how different Credit Suisse Demographics Research (2013), Rising youth unemployment: A threat to growth and stability Credit Suisse Demographics Research (2012), How demographics affects asset prices? Credit Suisse Demographics Research (2011), Macro Fiscal Sustainability to Micro Economic Conditions of the Old in the Oldest Five Countries Credit Suisse Demographics Research (2011), Longer lives, Changing life cycles: Exploring consumer and worker implications Credit Suisse Demographics Research (2009), A Demographic Perspective of Economic Growth Credit Suisse Demographics Research (2009), Demographics, Japanese current account & a disappearing savings rate Credit Suisse Demographics Research (2007), Demographics, Capital Flows & Exchange Rates. CS Demographics Research (2000) "The Demographic Manifesto-New Jobs, New People" W. Easterly and S. Rebelo (1993), Fiscal policy and economic growth, Journal of Monetary Economics, Volume 32, Issue 3, Page M. Horton and A. El-Ganainy (2012), Fiscal Policy: Taking and Giving Away, Finance & Development, IMF Why has recent macro-policy not been that effective? A demographic view 18

19 P Imam (2013), Shock from Graying: Is the Demographic Shift Weakening Monetary Policy Effectiveness, IMF Working paper. 13/191 International Labour Organisation (2013), Global Employment Trends for Youth 2013, A Generation at Risk IMF Policy Paper (Jan 2014), Fiscal policy and income inequality IMF Policy Paper (Sep 2013), Global Impact and Challenges of Unconventional Monetary Policies A. Leijonhufvud ed. (2001), Monetary theory and Policy Experience, Palgrave in association with IEA. E. Koenig, R Leeson and G. Kahn ed (2012), The Taylor Rule and the Transformation of Monetary Policy, Hoover Institution Press. K.G. Nishimura and E Takads (2012), Ageing, property prices and money demand, BIS Working paper 385. OECD (2013), Government at a Glance 2013, Fiscal sustainability Jong-Won Yoon, Jinill Kim, and Jungjin Lee (2014), Impact of Demographic Changes on Inflation and the Macroeconomy, IMF Working paper 14/210 Why has recent macro-policy not been that effective? A demographic view 19

20 Appendix Exhibit 28: Age specific fertility rate Birth per 1000 women France Germany Italy Japan UK US Source: UN, Credit Suisse Exhibit 29: Pension and health public expenditure % of GDP Source: OECD, Credit Suisse Why has recent macro-policy not been that effective? A demographic view 20

21 GLOBAL FIXED INCOME AND ECONOMIC RESEARCH Ric Deverell Global Head of Fixed Income and Economic Research GLOBAL DEMOGRAPHICS & PENSIONS RESEARCH Amlan Roy Head of Global Demographics & Pensions Research Mengyuan Yuan Anais Boussie