Demographic changes and inflation dynamics

Abstract

This study investigates the impact of demographic changes on inflation in Hong Kong, Singapore and Mainland China using the structural VAR methodology. It shows an increase in the youth population is inflationary, while an increase in the aging population is disinflationary. By affecting inflation expectations, demography directly impacts inflation, or indirectly through the interest rate channel, whereas its impact through the output gap or the wage channel is ignorable. However, the magnitude of the impact of demographic changes is small; with the variance decomposition revealing demographic shocks contribute to no more than 1% of annual inflation fluctuations over a 10-year horizon. Among the three economies, Hong Kong and Mainland China are more sensitive to demographic changes than Singapore. Although disinflation, as a consequence of an aging population, may not be the primary concern in the short term, the cumulative effect of aging on disinflation should not be ignored when the aging process persists or accelerates. Fiscal or monetary policies, in addition to measures to increase labour supply, should be taken when necessary to mitigate the effect of aging on inflation in the short-to-mid term.