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Bringing Down the House

The effect of aging on asset prices may make the rich world's problems worse.
Economist Staff, The Economist
September 26, 2011

Since the bursting of Japan's asset bubbles in the early 1990s, the country has undergone a long and deflationary process of debt reduction. During this period, Japanese policymakers have attracted criticism from (among others) Ben Bernanke, the chairman of the Federal Reserve, for their gradualist approach to reflating the economy. The critics' charge is this: that although the Bank of Japan (BoJ) pioneered many of the policies that the Fed and others have since followed-such as committing to zero interest rates and increasing bank reserves by the alchemy of quantitative easing-the Japanese central bank still did too little, too late.

Things look rather different in Japan itself, where some say the problem lies in a lack of demand for loans from the debt-strapped private sector, rather than a lack of supply. This is the hallmark of a "balance-sheet recession", a term coined by Richard Koo of the Nomura Research Institute to describe the process whereby households and companies pay down debts rather than embark on new spending.

In two speeches* this year, Kiyohiko Nishimura, deputy governor of the BoJ, has developed this line of thinking to help explain why Japan's balance-sheet adjustment has taken so long. Mr Nishimura blames the prolonged slump on ageing, which is furthest advanced in Japan, but is also occurring in many of the world's biggest economies. His central argument is that ageing depresses asset prices. That in turn makes deleveraging tougher because debt used to finance assets is harder to pay off without incurring losses. This, he says, may have grim repercussions for America and Europe.

The theory behind the link between ageing and asset prices is outlined in a recent working paper by Elod Takats of the Bank for International Settlements (BIS). In simple terms, the young and middle-aged save for old age by buying assets, often with borrowed money; the old sell them to pay for retirement. As the working-age population rises-as it did, for instance, after the baby boom-asset prices rocket because of increased demand. As baby-boomers reach retirement, the reverse may happen.

In his paper Mr Takats seeks to quantify this effect. He prefers to look at an international sample rather than data on single countries, because that enables more robust identification of the impact of ageing. He also focuses on house prices rather than financial assets, because they are less likely to be influenced by cross-border capital flows. Mr Takats applies two aspects of demography to BIS house-price data from 22 advanced economies: first, total population; second, the ratio of old people to the working-age population, or the old-age dependency ratio. Between 1970 and 2009, he finds that a 1% rise in GDP per person and a 1% rise in the total population each corresponded to about a 1% rise in real house prices. But a 1% increase in the old-age dependency ratio was associated with a 0.66% drop in real house prices.

Using United Nations projections, his analysis suggests that house prices will face strong headwinds in the next 40 years as populations age. American house prices, for example, will rise by about 80 basis points a year less than they would do if you strip out demographic factors, he reckons. For faster-ageing countries such as Japan, Germany and Italy, prices would fall by more than 1% a year, though he notes that other factors may offset the demographic effects and he does not expect a meltdown in prices.

Prices of financial assets do not necessarily shadow those of property: people tend to buy and sell stocks and bonds later in life than they buy and sell homes. But they are also affected by ageing as the old sell them to realise cash. A model developed at the Federal Reserve Bank of San Francisco finds that since 1954 there has been a high correlation between the ratio of Americans aged 40-49 to those aged 60-69, and the price/earnings ratio of the stockmarket. The implication of this relationship for share prices in the future is bearish, it says. Based on standard demographic and earnings assumptions, the San Francisco Fed's model suggests share prices will fall by 13% between 2010-21. The good news for America is that the relative proportion of middle-aged people should rebound in 2025, implying a strong recovery.

Such estimates should be treated with caution. Ageing, at least in the short term, is fairly predictable, so markets may have already discounted its impact on asset prices. Mr Takats draws attention to the fact that elderly people may end up working longer, which would reduce the pressure to sell their assets.

But the uncertainties run both ways. As Mr Takats points out, overstretched pension systems may spur retired people to run down their assets more aggressively than expected. The BoJ's Mr Nishimura ventures that the downward pressure on prices may be exacerbated by ageing in countries like Russia and China, whose entry into the global economy helped fuel the world's recent asset-price boom.

Grey market

If ageing does exacerbate the costs of a balance-sheet recession, what can policymakers do about it? The BoJ, Mr Nishimura says, has sought to counter some of the effects, such as the loss of lending expertise in the banking sector and risk aversion, through "truly unconventional" monetary policy, such as buying low-grade corporate bonds and exchange-traded funds to spur investment in riskier assets; and providing funds for banks to lend and invest in promising new fields, such as innovations for the elderly. But his overall message is stark: repairing balance-sheets when the population is ageing is much harder than when it is young. Some people, he cautions, regard the turmoil since 2008 as a "fleeting nightmare". But where ageing is endemic, there may be no going back to normal. As the title of one of his papers ominously puts it: "This time may truly be different."


 

Sources

* "Population Ageing, Macroeconomic Crisis and Policy Challenges", a speech by Kiyohiko Nishimura, June 2011
* "This Time May Truly Be Different. Balance-sheet Adjustment under Population Ageing", a speech by Kiyohiko Nishimura, January 2011
* "Ageing and asset prices", by Elod Takats, BIS Working Papers, January 2011

* "Boomer Retirement: Headwinds for US Equity Markets", by Zheng Liu and Mark Spiegel, Federal Reserve Bank of San Francisco, August 2011

© The Economist Newspaper Limited, London (September 24, 2011).




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