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Macroeconomic Impacts of Demographic Change. Warwick J McKibbin Centre for Applied Macroeconomic Analysis, RSPAS, ANU; Lowy Institute for International Policy, Sydney The Brookings Institution, Washington DC;.
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Macroeconomic Impacts of Demographic Change Warwick J McKibbin Centre for Applied Macroeconomic Analysis, RSPAS, ANU; Lowy Institute for International Policy, Sydney The Brookings Institution, Washington DC; Presentation prepared for the USDA Workshop on Demographic Change and the Global Food System, Washington DC 25 May 2005
Draws on • McKibbin W. and J. Ngyuen (2004) “Modeling Global Demographic: Change Results for Japan”, CAMA working paper 4/2004 • Battini N., CallenT. And W. McKibbin (2005) “The Global Impact of Demographic Change” IMF working paper – background paper to the September World Economic Outlook (Forthcoming) • McKibbin (2005) “Global Demographic Change and Japanese Macroeconomic Performance” Paper prepared for the ESRI collaborations Project conference, Tokyo, 14-16 February
Overview • Summary of Global Demographic trends • Goal of the Project • Macroeconomic issues • Alternative approaches • Our Approach • Results for stylized fertility decline in a 2 country model • Consequence of demographic change in 10 regions from 2004 to 2100 • Conclusions
Goal of the Project • Study the global macroeconomic consequences of demographic change with a focus on the likely consequences for saving and investment balances (therefore current accounts) and asset prices over time • Develop policy recommendations for national governments for how best to cope with these changes
We take it as given that to understand the international dimensions of demographic change you need to use some form of global economic model. • But existing models are inadequate in that they do not adequately include demographic factors
Macroeconomic Impacts of demographic change • Aggregate saving, consumption, wealth • Composition of consumption bundles • Investment rates • aggregate • across sectors • Labor markets • Government budgets • => General equilibrium impacts on trade and financial flows and asset prices
Alternative Approaches • Cross sectional/time series econometric estimation of aggregate saving and investment and growth equations • Calibrated OLG models of single economies • Calibrated/estimated DIGE/DSGE models
The Approach • Improve and apply the new generation of large scale global economic models to capture the many complex general equilibrium issues. • Based on a short cut approach to demographics in a dynamic stochastic general equilibrium (DSGE) model rather than an explicit multi-country overlapping generation (OLG) model
The Steps • Develop small scale versions of the larger models for development purposes • Develop and apply new theoretical and empirical research in the small scale general equilibrium models • Extend the research into more realistic large scale models.
The Models Used • We are taking a two-pronged approach doing the analytical/empirical work together but implementing in two strands of models • Bryant working with his version of the IMF Multimod model • McKibbin and co-authors working with the MSG3 and G-Cubed models
Our Theoretical Approach • Follows Yaari/Blanchard/Weil models as extended by Faruqee and Laxton • Demographics from the “bottom up” • Approximate an OLG model using a probability of death and exogenous profiles of birth and death rates to generate cohort adjustment over time • The demographic change is taken as exogenous and cohort aggregation effects are calculated outside the core model
Minimum Requirements • Adults are distinguished from children so we can capture the difference between youth and elderly dependency ratios • Country specific models for the major countries/regions so we can capture the asymmetries
Introduce empirical age earnings profiles • Labor income • rises with age and experience • reaches a peak in late middle age • then declines gradually for the rest of life • The shape of the age-earnings profile for individuals in the economy is assumed to be the same for all individuals and unchanged through time.
Introduce empirical age earnings profiles • But the demographic composition of the population can change over time. • Because aggregate labor income is obtained by aggregating over individuals that differ in age and experience, moreover, the bottom-up aggregation over individuals permits the demographic changes to influence both the aggregate level and the age distribution of labor income.
Introduce empirical age earnings profiles • The hump-shaped profile of earnings by age influences both the supply side and the demand side of the model economy's behavior. • Hence through these life-cycle effects, changes in demographics significantly influence macroeconomic outcomes.
Supply side effects • On the supply side, the earnings profile is an indicator of the changes in a cohort's relative productivity and its supply of labor over its lifetime.
Demand Side • On the demand side, the anticipated path of labor income determines the saving plans of consumers over their lifetimes.
Adults/workers • Emerge at age 17 from the pool of children • The adult maturity rate is the rate of emergence of adults as a percent of the total adult population • Are born with the productivity of the cohort alive in time t and then acquire productivity based on the estimate age earnings profiles over time. • Die at a constant rate over time (major shortcoming but needed for aggregation).
Children • Are born to adults and stay children for 16 years • Do not supply labour • Do not hold financial wealth • Receive transfers from adults (which grow at the rate of economy wide productivity growth) which they consume • Have a different birth rate (defined as the number of children as a percent of the adult population) than the adult maturity rate (defined as the number of new adults as a percent of the adult population) • Have a different mortality rate than adults
Simple Model • First consider a symmetric 2 country MSG3 model with demographics • Both countries are the United States • UU is United States • ZZ is foreign country
Consider a stylized shock • Japan size fall in the birth rate • Closed economy (shock occurs in both countries) • Open economy (shock occurs in ZZ economy)
Summary • Promising approach to incorporating demographics into global models. • Results suggest important implications of demographic change for asset prices and balance of payment adjustment – even when the coming shocks are anticipated.
Analytical Approach • Embed the “short cut: approach of Bryant et al (2003,2004) and McKibbin and Nguyen (2004) into the MSG3 model with 10 regions.
Sectors • Energy • Non-Energy
Countries • Japan • USA • Western Europe • Rest of OECD • Eastern Europe and the Former Soviet Union • China • India • Other Asia • Latin America • Other Developing Countries
Question posed and philosophical issues • We want to know the impacts of demographic change on the global economy from 2005 onwards • Develop a baseline projection of the global economy from 1985 to 2100 with a full demographic transition where countries are adjusting towards a common steady state demographic position from very different initial conditions
SImulations • The baseline will be changing over time because of a range of factors such as productivity growth and demographic change. We want to calculate just the impact of demographic change over the coming century
Calculating the Impact of Demographic Change • Solve the model again from 1985 to 2100 removing the demographic adjustment from 1985 • The initial conditions in 1985 will already have the expectations of a demographic transition in the initial asset stocks. • Allow some time for the asset adjustment to occur • then examine the difference between the results with and without the demographic transition from 2005.
Focus on Japan: Impacts on Japan of Japanese demographic change versus rest of world demographic change
