More Gray, More Volatile? Aging and (Optimal) Monetary Policy

IMF Working Papers, September 20, 2019

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Canonical URL: More Gray, More Volatile? Aging and (Optimal) Monetary Policy

Authors: Daniel Baksa, Zsuzsa Munkacsi
Date: September 20, 2019
Core finding: Based on advanced economies’ data and a DSGE-OLG model, aging leads to downward pressure on inflation and higher inflation volatility.
Novel contributions:
- First to use this framework to discuss how aging affects the transmission channels of monetary policy.
- First to examine aging and optimal central bank policies within this framework.
Key mechanism: Aging redistributes wealth among generations and the labor force becomes more scarce, which makes monetary policy less effective and implies central banks in more gray societies should react more strongly to nominal variables.

Empirical evidence on the inflation impact of aging is mixed; there is no evidence regarding the volatility of inflation (prior to this paper).
Model-based conclusions:
- Aging → downward pressure on inflation.
- Aging → higher inflation volatility.
- Aging → reduced effectiveness of monetary policy due to wealth redistribution across generations and increased labor scarcity.
- In more gray societies, central banks should react more strongly to nominal variables.

Central banks in aging (more gray) societies should:
- React more strongly to nominal variables in their policy reaction functions.
- Account for diminished effectiveness of traditional monetary policy transmission channels under aging demographics.
Consideration of optimal monetary policy needs to incorporate intergenerational wealth redistribution and labor supply scarcity patterns driven by aging.

Data scope: advanced economies’ data.
Modeling framework: DSGE-OLG (dynamic stochastic general equilibrium — overlapping generations).
Topics covered: transmission channels of monetary policy, optimal central bank policies under aging.