Latest / The Demographics Podcast with Fexingo: Aging Populations, Birth Rates, and Economic Impact / Why Falling Birth Rates Keep Inflation Low
Transcript
- Lucas: So Luna, I was digging through the Bank of Japan's latest policy statement this morning, and something really jumped out at me. They've been trying to get inflation up to 2 percent for over a decade now, and they just can't seem to get there. And I kept thinking: one of the biggest reasons is sitting right in the demographics data. Luna: You're talking about the shrinking working-age population, right? Because if there are fewer people of working age, you'd think wages would go up from labor scarcity, and that would push inflation higher. But Japan has seen the opposite. Lucas: Exactly. It's counterintuitive. Conventional economics says tighter labor markets mean higher wages, higher spending, and eventually higher prices. But Japan's working-age population — people aged 15 to 64 — has shrunk by over 10 million since the mid-1990s. And yet, the country has been stuck in a deflationary or very low-inflation environment for most of that period. Luna: So what's breaking the link? Is it just that older people spend less? Or is there something deeper going on? Lucas: A bit of both. First, older households do tend to consume less — they're past the big spending years of buying homes, raising kids, upgrading cars. But there's also a structural effect: a shrinking workforce means fewer new businesses, less innovation, and weaker aggregate demand. When there are fewer young people entering the economy, the overall growth rate of consumption slows down. Luna: And that's exactly what the Bank of Japan has been fighting. They've thrown everything at it — negative interest rates, yield curve control, massive asset purchases. And inflation still averaged around 0.5 percent for most of the 2010s. Lucas: Right. And what's interesting is that when Japan finally did get inflation above 2 percent in 2022 and 2023, it was almost entirely driven by external factors — the global energy shock, a weak yen, supply chain disruptions. As soon as those temporary effects faded, inflation dropped back toward 1 percent. The demographic drag on prices is that persistent. Luna: So are we saying that birth rates are a bigger factor in inflation than most central bankers admit? Because the Fed and the ECB don't seem to talk about it that much. Lucas: They're starting to. I was reading a speech from a Fed economist last year who argued that demographic shifts could lower the natural rate of interest — the so-called r-star — by reducing both potential growth and investment demand. And that has huge implications for monetary policy. If the neutral rate is lower because of demographics, then central banks can't cut rates as much during recessions before hitting the zero lower bound. Luna: That's a scary thought. It means future downturns could be harder to fight, especially if inflation is also low. We could end up in a Japan-style liquidity trap more often. Lucas: Which is exactly what the Bank of Japan has been wrestling with. And it's not just Japan — look at South Korea, Italy, even Germany. Their working-age populations are also shrinking or stagnant. And their inflation rates, outside of the recent global spike, have been low for years. Luna: But the U.S. is a bit different, right? We've had relatively higher birth rates and more immigration, so our working-age population is still growing, albeit slowly. Does that mean we're insulated from this demographic disinflation? Lucas: Partly insulated, but not immune. The U.S. working-age population grew just 0.2 percent annually over the past decade, compared to over 1 percent in the 1990s. That's a huge slowdown. And it's contributed to a decline in the labor force participation rate, especially among prime-age workers. We're not Japan, but we're moving in that direction. Luna: So if U.S. birth rates continue to fall, and immigration remains politically contentious, we could see a gradual downward drift in inflation expectations. Maybe not deflation, but persistently low inflation that makes the Fed's job harder. Lucas: Right. And actually, that brings up a question from a listener: if this demographic disinflation is so powerful, why don't central banks just target a higher inflation rate to compensate? Some economists have argued for raising the target to 3 or 4 percent precisely to give more room before hitting the zero lower bound. But that's a tough sell politically. Luna: And it only works if people believe you'll actually hit it. If demographics are pulling inflation down, you'd need an incredibly aggressive policy stance to overcome that headwind. The Bank of Japan learned that the hard way. Lucas: Exactly. So let me ask you this: if walking through the economy with us has made something click about this demographic-inflation link, it's worth knowing that these conversations stay ad-free because of listener support. If today was actually useful to you, the way these episodes stay independent is through people like you — buy me a coffee dot com slash fexingo. It's a small gesture that makes a big difference in keeping this going. Luna: Yeah, I think that's a fair ask. If you're getting value, it's a simple way to support the show. And if not, no worries — we're just glad you're listening. Lucas: So back to the U.S. scenario. Let's say birth rates stay low and immigration adds maybe half a million people a year. The Congressional Budget Office projects the working-age population will grow about 0.3 percent annually for the next decade. That's still positive, but it's down from historical norms. And the aging of the baby boomers means the share of the population in prime spending years is shrinking. Luna: That aging effect is actually measurable. Economists at the San Francisco Fed estimated that the changing age structure of the U.S. population reduced the natural rate of interest by about one percentage point from 1990 to 2019. So r-star is lower, which means monetary policy has less room to ease. Lucas: And that leads to a really interesting debate: should the Fed start incorporating demographic projections into their inflation forecasts more explicitly? Right now, they do it indirectly through potential GDP estimates, but they don't spend a lot of airtime on birth rates. Maybe they should. Luna: Well, the Fed has bought into the idea of secular stagnation — that weak demand and low inflation are structural. But I think demographics is the core driver of that stagnation. If you look at countries with the most severe demographic headwinds, they also have the most persistent low inflation and low interest rates. Lucas: Let's zoom out a bit. The global working-age population is still growing overall, but it's heavily concentrated in Africa and parts of Asia. That means the disinflationary pressure from demographics is not uniform. Countries like Nigeria or India might see the opposite — a demographic dividend that boosts demand and inflation. So central banks in those countries have a very different challenge. Luna: That's a crucial point. In a globalized world, demographic divergence could mean persistent inflation differentials across countries. Capital flows, trade imbalances, and currency movements will all be affected. It's not just a domestic story. Lucas: And it's why we're seeing central banks in aging economies like Japan and Europe keep monetary policy ultra-loose, while the Fed has been able to normalize somewhat. But even the Fed's tightening cycle was relatively modest by historical standards. Luna: So where do we go from here? If birth rates don't rebound — and there's no sign they will in most developed nations — central banks may have to accept permanently lower inflation targets or find new tools to stimulate demand. Lucas: Some have proposed things like helicopter drops or even directly financing government spending. But those are untested and politically dicey. The more likely path is that policymakers will come to accept inflation oscillating around 1.5 percent rather than 2, and interest rates staying near zero for longer periods. Luna: That would fundamentally change how we think about retirement saving, bond investing, and even real estate. Because low inflation and low rates are not necessarily good for everyone. Lucas: Right. Savers get squeezed, pension funds struggle, and asset prices get distorted. Demographics is the slow-moving force behind a lot of these big economic shifts. And it's something that doesn't grab headlines as much as a Fed meeting or a jobs report, but it's arguably more consequential in the long run. Luna: I guess the bottom line is: if you're trying to understand where inflation is headed, you need to look at how many babies are being born. It's a weird but powerful connection. Lucas: Exactly. And I think that's the kind of insight that makes this conversation worth having. For us, at least.