The age for austerity? Population age structure and fiscal consolidation multipliers

Journal of Macroeconomics

Advanced economies face two important trends: population aging and rising debt. In the coming years, it will be critical to understand how policies undertaken by governments interact with their changing age structures. In a panel of advanced economies, I show that fiscal deficit consolidation multipliers are highly sensitive to changes in population age. The demographic transmission of fiscal shocks differs between spending cuts and tax hikes, with important variation within working age and across dependent groups. Tax increases lead to weaker output response in relatively young economies, strengthening as population weights move to middle age, and falling again with large shares of retirees. Output response to spending, on the other hand, shows little change with demographics. The transmission of both policies to fiscal deficits suggests significant age dependence, with important impacts on multipliers when constructed as the ratio of cumulative output and deficit effects. Projecting forward, my estimates expect smaller multipliers as the baby boomer cohort fully retires, with demographics accommodating both tax and spending consolidations in terms of stronger deficit improvements, with tax policy displaying weaker output response.

Okay boomer... Excess money growth, inflation, and population aging

Macroeconomic Dynamics

What determines the strength of the relationship between money growth and inflation? A large literature suggests that it has weakened since the 1980s, without a definitive explanation of the cause. I explore how population age structure explains changes in the pass through of money growth rates to inflation. I show that the quantity theory of money holds over long time horizons, with sizable estimates of the impact of money growth on inflation in the short to medium term. Various measures of population age structure have significant impact on the strength of this relationship. These demographics account for an increase in the transmission of money growth to prices in the 1970s and a weakening throughout the great moderation. The baby boomer cohort, now in the age groups around retirement, may exert upward pressure on this money transmission to prices at present, with ambiguous implications in the future as low fertility and rising longevity persist.

Working Papers:

The Savings Glut of the Old: Population Aging, the Risk Premium, and the Murder-Suicide of the Rentier

with Alan M. Taylor

Population aging has been linked to a global savings glut and a decline in safe real interest rates. Conversely, risky real returns have not fallen as much, if at all, with equity risk premia on the rise. An existing literature can explain changes in safe rates using demographics. We go further to account for divergent returns on different assets as well as the underlying surge in the wealth-income ratio and its asset composition. Empirical evidence from historical panel data shows that demographic shifts are correlated with asset returns and risk premia. We build a heterogeneous agent life-cycle model with two assets (a safe bond and equity) and with aggregate risk. Aging demographics can help to simultaneously explain three key trends: the rising wealth-income ratio, the falling risk free rate, and an increasing risk premium. The shifts exert less pressure on risky returns as high-wealth elderly reallocate away from equities: aging makes retirement saving a "crowded trade" but more so for bonds. Projecting our model to 2050, aging pushes the safe rate below zero, but the risk premium remains elevated, as post-boomer demographics push asset returns to unprecedented and persistently low levels.

An Aging Dynamo: Demographic Change and the Decline of Entrepreneurial Activity in the United States

The rate of new business startups has fallen drastically over the last thirty-five years, a trend that accelerated after the year 2000. Other measures of business dynamism, such as the job reallocation rate, are consistent with this trend. This has raised serious concern, given the effect that young, high-growth firms have been shown to have on employment, and may also have on innovation and growth. The timing of this decline coincides with the start of a steady increase in both the life expectancy and average age of the workforce. I document that an individual's propen- sity to select into entrepreneurship follows a 'hump shape' as they age. To account for both individual behavior and aggregate trends, I construct a life cycle model of entrepreneurial choice, studying a number of channels that link demographic forces to entrepreneurial selection. I find that demographic channels can account for a large portion of the recent decline in startup activity. This model predicts that entrepreneurial activity will continue to decline as the pool of potential entrepreneurs continue to age. I conclude with a discussion of the potential policy tools that will affect individual's life cycle risk attitudes and the predicted effects that such measures will have on the rate of new business startups.

A Match Made in Maastricht: The Average Treatment Effect of the EMU on Trade

The currency union effect on trade has been a contentious topic, with a wide range of estimates on the true size of gains. One fundamental issue underlying many estimates is the lack of a accurate control group against which to compare outcomes, making it hard to understand the degree to which makes existing estimates even harder to interpret from the perspective of policy makers. Estimates of gains within the eurozone tend to be smaller, while the sovereign debt crisis in Europe caused many to question the long term viability of the union. It is crucial for the public debate over the costs and benefits of eurozone membership to bring more clarity to our understanding of the benefits from trade that such a union provides to its members. I propose a novel approach to this literature that applies inverse propensity score weighting as well as local projections to study both the traditional static estimates of trade as well as forecasts of the effect of currency unions on trade over time. I find that the static effect of currency unions on trade are in general still quite large for currency unions in general, but quite small for the emu. However, I find the puzzling result that the currency union effect on trade for the euro declined over the period from implementation until the recession in 2008. Since the expected effect should be fixed over time this suggests a deeper understanding of the simultaneous policy changes that take place over the period that may bias static effects upwards.

Coming Soon:

Stuck in the Middle with You: Structural Change and Inequality

with Andrew Padovani

The Question:

When industries grow at different rates, how do labor market frictions, coupled with age specific life cycle occupational choices affect the distributions of wages and wealth?

Early take:

Age compositions of industries and occupations suggest that younger workers are more flexible in allocating toward industries with rapid wage growh. This can be explained in a life cycle model with fixed cost of reallocating labor, which in turn generates Kuznets curves when trends in wage growth different between two industries.