Demographics Drive Up Interest Rates

AT BOCCONI UNIVERSITY AND DEUTSCHE BANK'S GENERAL SYMPOSIUM ON PENSIONS, A STUDY BY CARLO FAVERO AND VINCENZO GALASSO WAS PRESENTED, WHICH ANALYZES THE INFLUENCE OF THE AGE MAKEUP OF THE POPULATION ON GROWTH, INTEREST RATES AND OPPORTUNITIES FOR IMPLEMENTING STRUCTURAL REFORMS

Applying demographic trends to economic forecasts through a careful analysis of the age makeup of the population has resulted in two Bocconi scholars (Carlo Favero, Deutsche Bank Chair in Asset Pricing and Quantitative Finance, and Vincenzo Galasso, Director of the Bachelor in International Politics and Government) seeing as distant the threat of secular stagnation for the Euro area, but they consider it difficult to implement structural reforms. This was discussed this afternoon during the General Symposium on Pensions, organized by Bocconi University and Deutsche Bank in Milan, as part of the activities of Carlo Favero’s Chair.
 
The theory of secular stagnation, which Larry Summers has recently reexamined, predicts poor growth, combined with negative real interest rates and resulting financial instability. Favero and Galasso’s analysis demonstrates, however, that in the next 20 years in Europe we should expect a decrease in GDP per capita, but real interest rates will be positive once again.
 
The coming years will be characterized by an increase in life expectancy and an ageing of the population, with a low number of births, a gradual decrease in the population between 40 and 59 years old and an increase in over 60s. “While the relationship between age and GDP per capita is linearly negative, in the sense that it consistently declines from 20 years on,” explained Favero, “the age between 40 and 59 is when the most savings occur, contributing to a containment of interest rates, while the over 60 population, saving less, contributes to increasing them.” GDP per capita, therefore, is destined to decrease with the progressive ageing of the population, while a sharp increase of over 60s will bring real interest rates to a positive area.
 
“In this kind of situation, growth policies are of vital importance,” said Galasso, “and we therefore wanted to participate in the debate that counterposes structural reforms and macroeconomic adjustment policies.” All the available data demonstrate that middle-aged and elderly people have more negative opinions regarding reforms, liberalization, flexibility, policies on competition, globalization and free trade compared to those who are younger. Labor market reforms and product reforms penalize insiders in the job market in the short-term, therefore mostly people in the central age segments, while their benefits are enjoyed in the near future mostly by the young. Neo-Keynesian macroeconomic adjustment policies, however, would end up favoring mostly older people and insiders, who have a greater ability to influence the process of allocating public resources.
 
“Our results suggest, therefore, that the implementation of reforms will not be favored by the age structure of the population,” concluded Galasso. “And it should not be surprising that older countries are more inclined towards macroeconomic adjustments and younger countries are more for reforms.”
 
The study completed by Favero and Galasso and the concept itself of the General Assembly on Pensions originate from the research of the Deutsche Bank Chair in Quantitative Finance and Asset Pricing, an endowed chair established in 2010 and assigned to Carlo Favero. In 2016, Deutsche Bank confirmed its commitment to research progress in the field of finance, consolidating its support to Bocconi University and making the Chair permanent through a new gift. The Chair’s research activities focus on interactions between demographic trends, prices of financial assets and effects of the increasing longevity of individuals.

by Fabio Todesco
Translated by Jenna Walker