Organisation of households: Aging and financial cycles

Organisation of households: Aging and financial cycles

Phuah Eng Chye (14 April 2018)

It is unsurprising that there is a close relationship between aging and long-term financial cycles as a highly developed financial system is a prerequisite to achieving affluence. As economies become affluent and aging more pronounced, economic maturity sets in and sets off a number of events. The manufacturing sector hollows out. In the process, asset prices may experience a speculative bubble followed by a crash. Reflecting the loss of growth momentum, domestic capital investment weakens and the corporate sector shifts from being a net borrower to becoming a net lender. The continuous compounding in wealth accumulation leads to excess savings and lowers domestic interest rates.

Generally, aging exerts a persistent influence on long-term financial cycles through their effect on private and public savings and wealth accumulation, asset prices and interest rates. Noëmie Lisack, Rana Sajedi and Gregory Thwaites points out “the rise in life expectancy raises the economy’s desired level of wealth for two reasons. Firstly, people need to accumulate more wealth during their working life to fund their consumption over a longer expected retirement. In terms of the life-cycle profile of wealth, all else equal, this would mean that wealth rises more steeply and reaches a higher peak. Secondly, even without any change in behaviour over the life-cycle, the changing population age structure would imply rising aggregate wealth.”

E. Philip Davis point out in the initial stages of aging, savings is compounding and “risks may initially arise from a balance of payments surplus which leads to an appreciating currency and loss of competitiveness by domestic industry, generating credit losses by lending institutions…Such losses could be especially marked if aging is at the same time putting downwards pressure on economic growth rates and returns on physical capital. Exchange rate appreciation in this period may be aggravated by the degree of home bias among investors…This situation – i.e. where fiscal and monetary measures are taken in an attempt to correct the structural imbalance due to the demographic factor – is also likely to lead to the creation of financial bubbles”.

At the later stages of aging, the financialisation process reverses. The rising number of retirees triggers a drawdown of savings while welfare payments is exacerbated by rising dependency[1] and longevity. Fund decumulation leads to asset liquidation and falling prices with systemic consequences.

E. Philip Davis notes “solvency could be threatened for life insurance companies and defined benefit pension funds that had made undertakings based on expected returns on assets formed during the bull period” and there could be an “impact on the adequacy of funding and replacement rates offered by pension funds and life insurance companies.” These threats to fiscal and corporate solvencies have forced governments to reform their social security and pension schemes, raise retirement ages and rationalise healthcare costs.

Changes in demographic aging also affects monetary preferences. Patrick Imam points out “based on the life-cycle hypothesis, we would expect older societies to typically have a large share of households that are creditors, and to be less sensitive to interest rate changes, while younger societies would typically have a larger share of debtors with higher sensitivities to monetary policy…a general weakening of monetary policy effectiveness over time, with unemployment and inflation less responsive to interest rate changes as society greys.”

The potential implication is “the relative preference of inflation versus output stabilization is likely to change, as older households have on average larger asset holdings and, therefore, have more to lose from unexpected inflation. In addition, the increasing aversion to inflation may, ceteris paribus, lead to a lower optimal inflation target, while a declining real interest rate, which is viewed as an important consequence of aging is likely to work in the opposite direction.”

Noëmie Lisack, Rana Sajedi and Gregory Thwaites found “demographic change alone can explain 160 bps of the 210 bps decline in interest rates since the early 1980s…The model predicts an increase in house prices of over 45% since 1970…explains the doubling of the private debt-to-GDP ratio between 1970.”

Patrick Imam notes monetary policy interventions may need to be more aggressive “with higher variation in interest rates possible going forward” while if “monetary effectiveness becoming less potent, the burden to stabilize the economy and the financial system may increasingly be borne by other policy tools” such as the use of fiscal and macro-prudential policies to stabilize the economy.

Hence, as aging becomes more pronounced, one symptom of maturity is that the economy accumulates more savings than it could deploy productively[2]. Coen Teulings and Richard Baldwin observe “aging leads – other things being equal – to an increase in the required stock of savings. A greater supply of savings is one of the Wicksellian forces pushing the real interest rate down.”

An environment of low interest rates and excess savings creates conditions favourable to the formation of asset price bubbles. Coen Teulings and Richard Baldwin interpret that “bubbles are an alternative way for society to deal with excess saving when fiscal policy does not take up the challenge.” Hence, they suggest that policy-makers should be “addressing the excess saving, not fighting the bubbles” and “therefore to avoid the interest rate from falling that far by using fiscal policy to absorb the savings.”

Overall, the close relationships between aging and the financialisation process suggests secular stagnation is an imminent and predictable aspect of the financial cycle. This then raises the question of whether conventional models that did not predict the outcome of secular stagnation can be used to formulate policies to overcome it. It is likely that conventional frameworks based on fiscal and monetary theories may provide misguided advice and obscure the real weaknesses. In relation to addressing secular stagnation, fiscal and monetary policies should be supportive tools rather than a lead objective; otherwise it would result in stimulus for its own sake without lasting benefits.

What will be interesting to explore is whether, within the context of the financial cycle, the outcomes can be differently managed; i.e. secular stagnation can be overcome or, at least avoided or pre-empted. Maybe policy measures should focus on managing the course of capital destruction[3] or on rebalancing concentrations to sustain business dynamism or on qualitative issues in relation to the use of stimulus. In this regard, it is important to design policies that anticipate the longer-term trend of fund depletion and fiscal revenue shortfalls and that are tailored to the needs of an asset-rich and aging society.


Coen Teulings, Richard Baldwin (15 August 2014) Secular stagnation: Facts, causes, and cures. Voxeu.

E. Philip Davis (2002) “Ageing and financial stability” in H. Herrmann and A. Auerbach (eds) Ageing and financial markets, Heidelberg: Springer Verlag – Deutsche Bundesbank.

Noëmie Lisack, Rana Sajedi, Gregory Thwaites (31 January 2018) “Population ageing and the macroeconomy”. Bank Underground.

Patrick Imam (September 2013) “Shock from graying: Is the demographic shift weakening monetary policy effectiveness”. IMF Working Paper.

Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society

Phuah Eng Chye (7 April 2018) “Organisation of households: Aging, secular stagnation and population policies”.

[1] A shrinking ratio of workforce to support retirees

[2] Phuah Eng Chye “Organisation of households: Aging, secular stagnation and population policies”

[3] Phuah Eng Chye Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society.

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