Balance Sheet Adjustment under Population Ageing

This is a very interesting and thoughtful speech from Kiyohiko Nishimura of Bank of Japan.

He links the demographics with the current crisis and Japan’s crisis in 1990s. Interestingly, both these crisis have happened at a time when demographics are worsening for  the economies.

For demographics, he uses a variable called Inverse Dependency Ratio (IDR). IDR indicates how many people of working age it takes to provide for one dependent person. He shows via various graphs how this IDR peaks for Japan just at the time of its crisis in 1990s. And same trend we  see for US, Spain and Greece as well.

The Japanese ratio peaked around 1990, and it was in the very next year, 1991, that the Japanese Bubble peaked. The peak of the US ratio was between 2005 and 2010, and the peak of the US Subprime Bubble was 2007 (Fig. 1.1). The economically troubled countries of the eurozone have a similar pattern to Japan and the United States.

The ratios for Greece, Portugal and Spain have almost the same time profile, and all of them peaked around 2000-2005. The peak of the Spanish property boom was just after the ratio’s peak, and the financial problems of Greece also started at the same time. A particularly interesting case is Ireland, which showed a sharp rise in the ratio until around 2005. The bust of the country’s property market bubble was just a few years around the corner (Fig. 1.2). Incidentally, for the sake of completeness, I have included the figures for China (Fig. 1.3), whose ratio seems still to be rising rapidly, but will peak a bit later than in Euro-American countries. The peak will be around 2010-15, after which it will go down as rapidly as it is now going up. The inverse dependency ratios of many other Asian countries have a quite similar time profile to that of China.

What does this imply?

It simply means that recovery from the crisis will be much tougher. When you have a younger work population, the young ones would get into spending/investing etc and lead to economic recovery. But when you have  an older population which is expected to rise going forward, people will be saving/not consuming etc and saving for the old age.

On top of that you had high leverage in Japan and US as well. Japan had high leverage in Corporate and US in Household. Hence, the balance sheet adjustment is going to be very slow just like we saw for Japan.

To prove his point, Nishimura shows that in previous recessions activity did not decline  as the central bank cut rates. But in Japan’s 90 crisis and in US 2007 crisis, policy rate cuts have not had the desired impact.  He also shows how property prices in both US and Japan peaked before their respective crisis. In Japan prices have so far not recovered and we expect the same for US as well. The lower property prices made things difficult in Japan.

He says this mix of ageing with balance sheet adjustment leads to three issues:

  • Mobility declines –
  • Loss of human capital
  • problems in financial intermediation – as real economy does not pick up, banks fail to select winners.

These three factors then lead to:

  • Decline in growth prospects
  • Vicious circle of economy to finance – banks do not lend as lower productivity which further declines and so on. Excessive risk aversion sets in capital markets
  • Givt debt rises as public sector tries to replace demand of private sector

He then looks at BoJ recent policies. In the end he sums up:

In the bubble years, we often heard talk of this being the beginning of a new age of prosperity and that, as the title of the popular book says, “this time is different”. Since the bubble burst, people have tended to think the collapse was simply a fleeting nightmare and that we will eventually be back to the old normal, just as before. That may be true. However, if we recognize the problems arising from acute balance sheet adjustments when the population is ageing, there is the distinct possibility that this time may truly be different. 

(Emphasis mine)

An amazing speech. Not many have spoken about this interesting linkage (actually I dont know any) and gives it a very different and fresh perspective. It also explains why Japan economy remained stagnant over the years and is not expected to recover anytime soon. Moreover, raises qs over US and Europe recovery which are facing the same demographic discount going ahead.

It also  takes me to this recent article which said lost decade of Japan is a myth. Based on demographics, it grew faster than US. So, in a way US growth has been lower already.

Now it will be great if Rogoff and Reinhart again go back to economic history and tell us whether all this is true. Just like economic cycle we should be having a demographic cycle as well. In this demographic cycle, we should be seeing a larger number of world population moving from working age to old age and then the reverse. So, if we did see some crises amidst this population transition in the past, what was the final outcome? How much time did it take for things to come back to normal?

What a speech from BoJ Deputy Gov.

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3 Responses to “Balance Sheet Adjustment under Population Ageing”

  1. Why US HousehReuven Glick and Kevin J. Lansing old Savings have increased? « Mostly Economics Says:

    […] the ratio of household debt to disposable income has dropped from 130% to 118%. It takes me to this superb speech by BoJ official. He says in US, HH increased their leverage levels (compared to Japan whose corporates leveraged) […]

  2. Demographics problem – not just limited to developed economies « Mostly Economics Says:

    […] posted on this superb speech from BoJ chief who shows why this recession could be different because of […]

  3. About India Says:

    About India…

    […]Balance Sheet Adjustment under Population Ageing « Mostly Economics[…]…

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