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Fed’s economic models applied to a past era

Economic growth
By Paul Hodges on 29-Oct-2016
FTThe Financial Times has kindly printed my letter below, welcoming the Fed’s decision to address the impact of demographics, but arguing that it needs to focus on demand issues, given the impact of today’s ageing populations.

Sir, It is good to see the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But as John Authers confirms in his excellent analysis of the Fed’s new research paper (“The effects of ageing”, The Big Read, October 26), its continued focus on supply-side issues means it is looking down the wrong end of the telescope.

The Fed’s approach might have made sense in the past, when demand was on a growth trajectory as the baby boomers joined the 25-54 cohort, which drives wealth creation. But today’s problem is growing overcapacity, not lack of supply, given that the ageing baby boomers already own most of what they need, while their incomes are declining as they enter retirement.

The problem is that the Fed’s economic models were developed at a time when the population effectively contained only two main segments — the under-25s and the 25-54 cohort. From a policy perspective, the number of over-55s was too small to be of interest. But this is no longer true, as increasing life expectancy means the baby boomers can now hope to live for another 20 years after reaching retirement age.

Equally important is that since 1970, fertility rates have been below the replacement level of 2.1 babies per woman in the developed world. Thus the relative size of the wealth creator cohort has been reducing for the past 45 years, while the numbers in the 55-plus cohort have been increasing. The result is that the ageing baby boomers are now nearly a third of the developed world’s population.

Policymakers therefore need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.

Paul Hodges
Chairman,
International eChem