One of Stratton Street’s core beliefs is that secular trends such as demographics are constraining growth rates: declining growth has been matched by declining inflationary pressures and lower interest rates. We do not see a reason for this trend to be derailed.
Japan is often pointed to as being one of the most advanced along this path. Nao Sudo and Yasutaka Takizuka’s January 2018 Bank of Japan Working Paper ‘Population Ageing and the Real Interest Rate in the Last and Next 50 Years’ makes some interesting observations in this respect. This study looks at past and future aspects using an overlapping generation (OG) model calibrated to Japan’s economy.
Based on their baseline simulation they find that for Japan between 1960 and 2015, ~270 of the 640 bps decline in real interest rates is attributed to changes in the demographic structure. Interestingly, their study finds that for 2016 onwards changes in the demographic structure have only a minor impact on the real rate.
Sudo and Takizuka rationalise a lessening future demographic effect as follows: ‘In Japan, over the last 50 years, the fertility rate has dropped from 4.6% in the 1960s to -0.7% in 2015, which results in a decline in the growth rate of the working age population from 2.0% to -1.4% during the period. In the next 50 years, the fertility rate will drop by only 0.5%, which makes the growth rate of the working age population almost unaltered. Similarly, life-expectancy has risen by 12 years over the last 50 years, but it will rise by only 4 years over the next 50 years.’ Nevertheless, they still expect past demographic changes to continue to exert downward pressure on real rates: increased longevity ‘is a permanent change and affects households’ saving behaviour permanently, bringing about a persistent negative effect on the real interest rate.’
Demographic trends have important implications for asset markets: According to the United Nations, the entire populations (not just those of working age) of 48 countries or areas in the world are expected to decrease between 2015 and 2050. For us, this implies a weakened growth and inflation outlook and supports a lower level for real rates.