Monetary Policy, Demographics and the Business Cycle

Regents Of The University Of Michigan - Ann Arbor, Ann Arbor MI

Investigators

Abstract

Abstract Understanding how aging affects macroeconomic policy becomes increasingly important as baby-boomers retire in the U.S. and there are shifts in the age-composition of population in the world. This project documents how changes in age distribution affects the response of incomes and employment to monetary policy. Preliminary results indicate that states with many young residents appear less sensitive to monetary policy, whereas states with many middle-aged residents appear more sensitive. The project explores the underlying reasons of such differences and uses these results to construct models of the economy that more accurately reflect the demographic changes observed. The research improves the understanding of how monetary policy impacts the economy in relation to demographic changes. Thus, the project helps the Federal Reserve and the private sector anticipate changes to the economy brought about by an aging US population. Similarly, the research has implications for monetary policies of other economies where there are shifts in age-composition. The project uses the U.S. states as a laboratory to explore how age distribution influences monetary policy. The proposed research looks at how state level variables such as income and employment respond to monetary policy initiatives. These responses are then related to the age composition of the state, while controlling for other reasons that states may differ. Preliminary results indicate that incomes of all age groups respond more to interest rates in a state with more middle-aged residents. These preliminary results indicate that what matters most to an individual is not their own age, but the age distribution of the state in which they live. The proposal further looks at the mechanism that drives this sensitivity. Potential mechanisms include greater sensitivity of construction and proprietor?s income to the proportion of the middle aged and differences in the elasticity of demand across age groups. In the theoretical component of the proposal, empirical results are used to construct models of the economy that accurately reflect the demographic influences we observe. Explicitly considering demographics improves the understanding of monetary policy transmission and has broader implications on the economy as population ages and baby boomers retire. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.