Can age structure forecast inflation trends?

Abstract

The demographic age structure influences the aggregate of individual economic decisions. Standard macroeconomic models imply that inflation pressure will covary with the age distribution unless accommodated by monetary policy. We estimate the relation between inflation and age structure on annual OECD data 1960–1994 for 20 countries. The result is an age pattern of inflation effects consistent with the hypothesis that increases in the population of net savers dampen inflation, whereas especially the younger retirees fan inflation as they start consuming out of accumulated pension claims. This can be explained, for example, with life-cycle saving behavior combined with a cumulative process of inflation, but other mechanisms are also consistent with the results. In any case, the results suggest that demographic projections may be useful for long- and medium-term inflation forecasts. Forecasts from our panel model catch the general downward trend in OECD inflation in the 1990s. However, useful forecasts for individual countries need to incorporate more country-specific information.