The Daily Update - Inflation and demographics

Milton Friedman famously stated that, ‘Inflation is always and everywhere a monetary phenomenon’. We don’t have enough space to make an economic case for why this assertion may or may not be correct. Let’s instead make a counter statement that, ‘Inflation is always and everywhere a population phenomenon’.

Whilst we are all familiar with the idea that supply and demand affects the price of goods, we don’t really think of the supply and demand of people in quite the same way. Clearly the unemployment rate will be heavily influenced by the rate of population growth in an economy, but surprisingly there is insufficient academic research which has explored the link between population growth and inflation.

Last year Moody’s published a report which studied the relationship between population growth and inflation using a number of regression models that took cross-sectional data between 1962 and 2015 across 27 countries. One of the models provided strong statistical evidence that a decline in the rate of population growth caused a significant decline in inflation. Moody’s estimated that a 1% increase in the population growth rate on average resulted in a 0.26% rise in inflation, whilst a decline in population of similar magnitude resulted in very significant drop in inflation of 2 percentage points.

Given that Japan’s working age population started to decline in the mid 1990’s and the overall population reached a peak in 2010, Moody’s analysis provides an intuitive explanation as to why Japan has seen virtually zero inflation for the past 20 years. Given Japan’s working age population is expected to shrink by more than 30% between now and 2050, it seems likely that Japan will continue to face severe deflationary pressures for at least the next 20 years, regardless of the so far futile efforts of the Bank of Japan.

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