Shock from graying: Is the demographic shift weakening monetary policy effectiveness

Abstract

There is mounting evidence that in advanced economies, changes in monetary policy have a more benign impact on the economy-given better anchored inflation expectations and inflation being less responsive to variation in unemployment-compared with the past. We examine another aspect that could explain this empirical finding, namely the demographic shift to an older society. The paper first clarifies potential transmission channels that could explain why monetary policy effectiveness may moderate in graying societies. Then, using Bayesian estimation techniques for the USA, Canada, Japan, the UK and Germany, a weakening of monetary policy effectiveness over time with regard to unemployment and inflation is confirmed. After proving the existence of a panel co-integration relationship between ageing and a weakening of monetary policy, the study uses dynamic panel ordinary least squares techniques to attribute this weakening of monetary policy effectiveness to demographic changes. The paper concludes with policy implications.