DEMOGRAPHY AND FINANCIAL MARKETS

Abstract

The world is in the midst of an unprecedented demographic transition. In developed and developing countries alike, populations are ageing as fertility rates decline and longevity increases. Together, these forces imply slower population growth and an increasing share of the elderly in the population, although the extent and speed of these changes will differ signifi cantly across countries. Demographic change has many important implications for fi nancial markets, including through its infl uence on labour supply, saving behaviour, capital accumulation, asset returns, international capital fl ows and the relative demand for different types of assets. The likely magnitude, and even the direction, of these effects is the subject of considerable debate. Most prominent perhaps is the question of what might happen to asset prices. Some studies suggest that the attempts of large cohorts of retirees to sell their assets to smaller cohorts of workers will trigger an ‘asset-price meltdown’. Other studies argue that these effects will be relatively minor. Much of this debate centres on the validity of the life-cycle hypothesis (LCH), whereby people will tend to save a lot during their peak earning years and run down their savings during retirement. Hence, changes in the age distribution can infl uence aggregate saving. It is also important to account for the labour market effects of demographic change. In principle, a decline in fertility, by reducing the relative size of successive age cohorts, will reduce the supply of labour and raise the capital-labour ratio. On the other hand, rising longevity will encourage longer working lives (if retirement ages are fl exible and health improves later in life), which by itself would push down the capital-labour ratio. However, longer lives are also likely to imply extra time spent in retirement. The need to fund these additional years in retirement will contribute to capital accumulation. 2