Aging Populace Informs Monetary Policy

By Esther George

Editor’s Note: The following is excerpted from a speech by Esther L. George, president and CEO of the Federal Reserve Bank of Kansas City, delivered at a forum in Helsinki, Finland, on aging and the economy.

Demographic trends are reshaping the U.S. labor force, leading economists and policymakers to rethink the key macroeconomic parameters that drive decision making, and reassess their views about the economy’s longer-run growth potential. Like melting glaciers, changes in global demographics are difficult to see in the near term, but over time they will reshape the landscape. Structural changes of the last 25 years have only gradually reduced the economy’s potential growth rate, its natural rate of interest, and unemployment, but they must be considered in the context of how we respond to business cycle fluctuations. Here are three observations:

First, the share of older individuals (age 55 and up) in the labor force has continued to increase. Twenty-five years ago, older individuals made up roughly 10 percent of the workforce; today, that share has more than doubled. At the same time, the shares of prime-age (age 25 to 54) and young individuals (age 16 to 24) in the labor force have declined. These demographic factors continue to put downward pressure on labor force participation.

Starting in the last recession, we saw labor force participation rates decline steadily. Over the past five years, the participation rate has stabilized as market conditions have improved. One of the important implications of long-term demographic shifts relates to what is known as the trend unemployment rate. Research shows that the changes in the age and skill composition of the labor force have systematically lowered the trend unemployment rate over the past 25 years.

As estimates of the natural rate of unemployment have declined, the scope for monetary policy to foster lower unemployment rates without generating inflationary pressures has increased. Uncertainty about exactly where those natural rates of unemployment might currently lie requires us to be cautious, examine a wide range of information, and continually update the parameters we use as new data arrives.

Second, this shift in labor force composition has coincided with dramatic changes in skills demanded by employers, due to technological advancements, and has resulted in a phenomenon known as job polarization. Job opportunities have shifted away from middle-skill occupations that lead to a middle-class standard of living, and toward high- and low-skill occupations.

Skills demanded in the labor market are rapidly changing, rendering the skills of many less-educated workers obsolete. Equipping workers with new skills in the face of rapid technological advancements continues to be a key issue for labor force participation and policymakers.

Third, is how these demographic forces interact with and influence the outlook for the U.S. economy. In housing, for example, a combination of forces has resulted in high housing prices and rents. These high prices disproportionately impact younger adults as they delay forming households, marriage and having children.

Downsizing by baby boomers could significantly increase demand for new multifamily construction, especially in the suburbs. This downsizing, together with the mortality associated with age, would be expected to free up existing single-family homes. Younger households who move into these homes will free up multifamily units for newly forming households. With housing being a key fulcrum of monetary policy and a sector we know can be prone to boom and bust cycles, these developments will require careful monitoring.

The implications of demographic change and other key structural economic relationships for monetary policy have already played out at the Federal Open Market Committee. According to the Federal Reserve’s Summary of Economic Projections, popularly referred to as the “dot plot,” the median projection for the long-run growth rate of real GDP has come down, the median projection for the long-run unemployment rate has also fallen dramatically, and the median projection for the long-run interest rates has come down notably. Understanding that considerable uncertainty remains around these estimates, policymakers must remain attuned to changes in macroeconomic trends such as aging demographics if we are to achieve our objectives for the economy.

Esther L. George is president and CEO of the Federal Reserve Bank of Kansas City.

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