Risk & Economy » Demographics and inflation: An age-old problem

Demographic effects have reduced OECD inflation by 0.5% over the past 10 years, according to a report by Legal & General Investment Management.

The report considers the correlation between slower population growth and inflation in the past decade, and forecasts how inflation rates will be impacted by future government approach to demographics.

One theory behind the correlation explores the link between population growth and demand, with a higher population leading to higher demand for limited resources, resulting in increased prices. An alternative theory focuses on supply, with workers being deflationary due to the fact that they consume fewer goods than they produce. On the other hand, young children and pensioners are inflationary by only consuming and not producing goods.

Legal & General Investment Management found that both factors have contributed to the demographics/inflation equation in recent years, but that looking ahead, the inflation outlook becomes “more ambiguous”.

The asset manager highlighted two opposing trends: a reduction in population growth caused by decreasing fertility rates, leading to a deflationary effect; and rising life expectancy alongside the retirement of babyboomers – boosting inflation by increasing the number of dependents.

The inflation outlook may depend on how the government responds to its population challenges, with Legal & General Investment Management outlining a five-stage process of demographic despondency.

  1. Disillusion: Government battles labour shortages and increasing health and pension costs, with health and social care being a labour intensive yet low productivity sector.
  2. Renege: Government could renege on earlier promises to pensioners, but this proves difficult to implement.
  3. Squeeze: Government will squeeze the population to tighten fiscal policy.
  4. Populism: The population will eventually vote for change in an attempt to reverse austerity.
  5. Debasement: Risks of higher inflation – both domestically generated and imported.

But where does the UK fit into this, and what is the inflation outlook for other countries, such as Japan and the US?

To discover more about inflation risk, download this white paper from Legal & General Investment Management.