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Boom or bust? Economic impact of ageing populations and lower birth rates

An unionist leads an demonstration against pension reform in Rennes, France. April 13, 2023.
An unionist leads an demonstration against pension reform in Rennes, France. April 13, 2023. Copyright Mathieu Pattier/AP.
Copyright Mathieu Pattier/AP.
By Eleanor Butler
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Life expectancy is rising, birth rates are falling, and pension systems are starting to creak - so what does ageing mean for interest rates and the wider economy?

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By 2050, the number of people aged 65 and over is set to rise to 1.6 billion globally. This is more than double the figure seen in 2021. 

The trend is driven by two intrinsically positive factors: improved population health and female autonomy. Whilst people are living longer, women’s education is also improving, meaning they’re generally having fewer children.

The effects of an ageing population are more concerning than its catalysts. Just last year, many of the world’s eyes followed the political unrest in France. When President Macron government’s announced it wished to raise the retirement age from 62 to 64, the full force of French protest culture was unleashed. 

Two years of extra work, according to Macron, was necessary to sustain the fiscal burden of an ageing population. The French saw this as an attack on their famously-safeguarded labour rights. As economic arguments fell on deaf ears, the reform was forced through the National Assembly without a vote.

Balancing the burden and the budgets

Although Macron’s stance was unpopular, it was a response to a bread-and-butter economic principle. If the ratio of pensioners to younger people grows, a greater burden is placed on government budgets. 

According to Eurostat, the old-age dependency ratio in the EU was 33% in 2022, meaning there were just over three working-age adults (15-64) for every person aged 65 or more. By January 2050, state spending on healthcare and pensions is likely to grow, as the ratio looks set to hit 56.7%.

Effect of an ageing population on productivity

The effect of ageing on productivity is fuelling equally painful predictions. If an economy has fewer working-age people, businesses may struggle to fill positions. This would stifle the output of goods and services, harming international competitiveness. 

Until recently, the eurozone's demographic shift wasn’t hugely damaging for productivity. During the first 20 years of the new millennium, the number of older people in the workforce grew. Longer-working lives counterbalanced the rising old-age ratio dependency, a consequence of improved health and a jump in pension ages.

The problem for governments is that this won’t last forever. The Covid-19 pandemic has killed the appetite of many older workers to return to the day job. Added to this, raising pension ages further is not an easy political route, as Macron knows only too well. 

For the short term, immigration can help to fill labour gaps, but it may not be a sustainable solution. The future flow of young workers to ageing nations is heavily dependent on how demographics evolve in sending countries, often in the Global South. Some of these ‘supplier’ states are currently suffering from their own productivity problems, as the young leave home for international prospects.

Yet even with government budgets hanging in the balance, the demographic shift hides something of a paradox. States may be splashing the cash, but what if the debt wasn’t so damaging? If ageing populations bring down interest rates, this could be the case.

Impact of an ageing population on interest rates

To unpack this phenomenon, we have to understand the role of saving. When the demand to deposit money in the bank is high, credit is more abundant. According to the rules of supply and demand, this will make lending cheaper - and the inverse is also true. Yet at the centre of this question is one uncertainty: how do older consumers manage their money?

It’s possible to distinguish between two different narratives here. On one hand, if the silver generation start to run down their savings, they have the potential to push up interest rates. This is the case put forward by Charles Goodhart, former official at the Bank of England. In Goodhart’s scenario, we get a picture of pensioners, freshly-free of work, ploughing through their savings as they edge towards the twilight years. That said, not everyone agrees.

"It’s important to look at the whole shift in the population pyramid and not just think of ageing as a one dimensional shift," explained Joseph Kopecky, Assistant Professor of Economics at Trinity College Dublin. He argued that whilst Goodhart’s model might one day become a reality, the current effect of mid-to-late stage workers mustn't be underplayed. 

Thrifty boomers, financially preparing for retirement, are pushing up the savings rate. Even when they do bring their careers to a close, it’s also debatable how frivolous they’ll be. A desire to leave an inheritance often leads older consumers to tighten the purse strings - good news for their kids.

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However, whilst boomers are counting the pennies, what is happening to the other age groups? Many economists believe that as life expectancy rises, so will saving levels across cohorts. The reason is simple: if you’re preparing for a longer retirement, you’re likely to build up bigger reserves. As people across the population save more, this will increase the supply of funds. If demand for investment remains constant, interest rates will then go down.

This cheap lending model may, of course, seem baffling in the current climate. Across major economies, borrowing costs have spiked, growth is stagnating, and banks are nervous to move. Yet underneath short-term shocks are underlying trends.

"During the period before this post-Covid inflation, the ECB was conducting very loose monetary policy,” said Kopecky. "They were still struggling to get inflation up to 2%. ... All this supports the story that there is something else pushing interest rates further down."

Reduced borrowing costs are a double-edged sword, as low interest rates also mean meagre returns. That said, if states want a silver lining, they may just have found one. 

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Whilst an ageing population is likely to squeeze state finances, it will ironically be easier to borrow. Future interest rates, vulnerable to a range of variables, are impossible to plot with certainty. In this case, policy makers will be looking to their elders. As countries with the highest dependency ratios weather the growing pains, the youngsters will be taking notes.

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