It's the Demography, Stupid!

Thanks to my son, John, for linking me to a story from yesterday's Financial Times with the provocative title of "It's the Demography, Stupid," drawing upon Bill Clinton's successful campaign slogan from many years ago that "It's the Economy, Stupid." The article itself is mainly about the effect of demographic change (especially aging) on the interest rate--more specifically, on the "equilibrium interest rate (r*)". 

Why is there a link between r* and demography? Remember that the equilibrium real rate of interest is that which ensures that savings and investment in the economy are equal in the long run. If ex ante savings exceed investment, r* declines, and vice versa. Since the savings behaviour of households is clearly affected by the age distribution of the population, and the investment behaviour of the corporate sector is affected by the labour supply, it is obvious that demography matters a lot for the determination of r*.

Now, I admit that I did not remember what the equilibrium real rate of interest was, so that was my lesson for the day. Life has also taught me that when economists talk about "equilibrium" we should probably stop listening, but in fact that is because demographic change does indeed make equilibrium an elusive concept. The economy needs to adapt to demographic change, rather than pretending that it does not exist, and the author of this story--Gavyn Davies (a British economist)--is pushing that agenda. If you have read my book, you know my belief that demography underlies almost everything that happens in the world, in one way or another. The more of us who understand that, the better off the world will be.