Ageing, interest rates, and financial flows

The median age of the global population is presently increasing by nearly three months every year. Over the next couple of decades, almost every country in the world is set to experience an unprecedented increase in the share of elderly population. This development has the potential to fundamentally affect the functioning of economic and financial systems globally. This study concentrates on the effects of ageing on the evolution of global interest rates and financial flows. The study uses a 73-cohort general equilibrium overlapping generations model of five major economic areas (USA, EU-15, Japan, China, and India). Utilising actual population data and UN population projections, the model yields predictions for major economic and financial variables up to 2050. The model predicts a decline in global equilibrium real interest rates over the next two decades, but the size of the decline depends crucially on the future evolution of public pension benefits. If the present generosity of pension systems is maintained – leading to a steep increase in the cost of the pension systems – the maximum decline of interest rates is projected to be about 70 basis points from present levels. If pension benefits are reduced to offset the increasing cost pressures, the decline in global equilibrium interest rates can be much larger, while increases in the retirement age work in the opposite direction. The results do not anticipate a ‘financial market meltdown’ – a collapse in asset prices associated with the retirement of the baby- boomers – predicted by some. On the contrary, bond prices should fare fairly well over the next three decades. The main reason for this is that increasing life expectancy at retirement creates a need for higher retirement saving – in the future, people will want to retire wealthier than they do today. This trend more than offsets the negative effect of the retirement of baby-boomers on asset demand.Ageing, real interest rates, financial flows, public pension systems

Ageing, interest rates, and financial flows

The median age of the global population is presently increasing by nearly three months every year. Over the next couple of decades, almost every country in the world is set to experience an unprecedented increase in the share of elderly population. This development has the potential to fundamentally affect the functioning of economic and financial systems globally. This study concentrates on the effects of ageing on the evolution of global interest rates and financial flows. The study uses a 73-cohort general equilibrium overlapping generations model of five major economic areas (USA, EU-15, Japan, China, and India). Utilising actual population data and UN population projections, the model yields predictions for major economic and financial variables up to 2050. The model predicts a decline in global equilibrium real interest rates over the next two decades, but the size of the decline depends crucially on the future evolution of public pension benefits. If the present generosity of pension systems is maintained – leading to a steep increase in the cost of the pension systems – the maximum decline of interest rates is projected to be about 70 basis points from present levels. If pension benefits are reduced to offset the increasing cost pressures, the decline in global equilibrium interest rates can be much larger, while increases in the retirement age work in the opposite direction. The results do not anticipate a ‘financial market meltdown’ – a collapse in asset prices associated with the retirement of the baby-boomers – predicted by some. On the contrary, bond prices should fare fairly well over the next three decades. The main reason for this is that increasing life expectancy at retirement creates a need for higher retirement saving – in the future, people will want to retire wealthier than they do today. This trend more than offsets the negative effect of the retirement of baby-boomers on asset demand.ageing; real interest rates; financial flows; public pension systems

Should unemployment benefits decrease as the unemployment spell lengthens?

It has become a conventional wisdom in economic policy debate that in order to minimise adverse effects on employment, unemployment benefits should decrease with the unemployment spell. This paper, using a series of simple search models, shows that the theoretical result regarding the optimality of a declining unemployment benefit profile is largely a result of specific modeling assumptions and fails to hold in a more general setting. While any pure reduction of unemployment benefits always improves employment, a redistribution of unemployment benefits from the long-term unemployment in favour of the short-term unemployed can either increase or decrease unemployment and unemployment benefit expenditure. The direction of the effect depends, inter alia, on the structure of unemployment and on the extent to which employed workers can reduce their lay-off probability.unemployment benefit; unemployment; search models

Credit Crunch Caused Investment Slump? An Empirical Analysis Using Finnish Data

The objective of this paper is to empirically analyze and quantify the effect of changes in the supply of bank credit on private investment. Particular interest is placed on the role of the credit crunch in explaining the collapse in private investment in the early 1990s. Using a vector autoregressive econometric model, it is shown that the credit supply plays a statistically significant and economically important role in determining investment. The effect of credit on investment comes through with a lag of about a year and persists for several years. Money supply is a powerful investment predictor in a bivariate relation, but loses its significance completely once credit is included in the model. Hence, in the light of history, it appears that the money supply has had little effect on investment except as relayed through credit and, to a lesser extent, through the interest rate. On the other hand, since strong contemporaneous comovements were found between money and credit, the contemporaneous effect of money on credit may be considerable. In general, the results were found to be consistent with the credit view of the monetary transmission mechanism: monetary policy affects both sides of bank's balance sheets — money supply and credit supply — and credit seems to be the more important predictor for investment. It is estimated that positive shocks to the credit supply during 1986–1988 raised the peak for private investment in 1990 by about FIM 25 billion annually. On the other hand, the subsequent negative shocks deepened the collapse of investment by approximately FIM 20 billion annually.credit crunch; private investment

From Policy Rate to Market Rates: An Empirical Analysis of Finnish Monetary Transmission

In this paper we analyse the empirical relevance of the mechanisms through which the Bank of Finland's actions are transmitted to the Finnish economy. We concentrate on the first stage of the monetary policy transmission mechanism; namely, the effect of the Bank's actions on domestic market interest rates and the exchange rate. The questions we analyse include: What is the impact of a change in the Bank of Finland's one month tender rate on interest rates of longer maturities and on the exchange rate? How do Finnish interest rates and the exchange rate react to turmoil in foreign money and bond markets? To what extent can recent developments in Finnish interest rates be attributed to the Bank of Finland's policies? We find that the effect of a monetary policy shock is limited to the short end of the yield curve. Changes in the Bank of Finland's tender rate seem to signal the future path of short rates for a period of 1 - 2 years. On the other hand, Finnish bond rates appear to follow closely circumstances in the international financial market and do not seem to react systematically to changes in the Bank of Finland's tender rate. We find that monetary policy has contributed little to the large swings in Finnish bond rates experienced over the last few years. Most of the variation in bond rates can be attributed to changes in international long rates and changes in the perceived overall credibility of the Finnish economy.monetary policy transmission; VAR models; Finland

Monetary Policy for Smoothing Real Fluctuations? – Assessing Finnish Monetary Autonomy

The possible participation of Finland in the Stage III of the European Monetary Union would constitute a major change in the operating environment of the Finnish economy. As a member of the common currency area, Finnish interest and exchange rates would no longer be determined by domestic monetary policy or domestic financial market reactions, but would instead be given by the European Central Bank and the European financial markets. Would this increase the severity of business cycles in Finland? This is the question the present paper seeks to analyze. In the first part of this paper, we review and evaluate the existing econometric work on the consequences of the European Monetary Union. Although the empirical work on the subject is abundant, it suffers from a narrow focus. Most of the research follow a highly simplistic empirical implementation of the traditional Keynesian theory of optimal currency areas and measure the desirability of a currency union by cross-country correlations of certain macroeconomic variables. We find the results obtained in those studies hard to interpret, and argue that – particularly when measured in a mixed exchange-rate system as has prevailed in Europe – simple macroeconomic correlations do not convey any meaningful information about the desirability of a currency union. In the second part we present an alternative approach to the empirical analysis of the topic. We construct a structural vector error-correction system to quantify the extent to which monetary autonomy has served to stabilize the real economy in Finland. This model is applied to analyze directly the consequences of Finland's possible entry into the European Monetary Union. The results suggest that monetary autonomy has played some role in insulating the real economy from the effects of shocks. In particular, adjustments of the nominal exchange rate appear to have stabilized the real interest rate and, consequently, smoothed the changes in domestic demand. However, this role has been relatively small, and given the uncertainties involved, it is possible that the effect has actually been negligible. Overall, we find no strong evidence to support a claim that monetary autonomy has served to stabilize significantly the Finnish economy.EMU; optimal currency area; Finland; structural VAR models

Time-Varying Markups: Empirical Analysis of Markups in Finnish Industries

In this study, we analyse variation of markups in Finnish industrial sectors, both between industries and over time. The study finds evidence that: - Since the beginning the 1980s, practically every Finnish industrial sector has been able to extract a positive markup. - The average industrial markup has apparently declined over time. In addition to the declining trend, there seems to be procyclical movement in markups. - Despite of the decline in average markups, most industries maintained positive markups in 1995. The same reservations apply to these results as to corresponding macro-level analysis of markups, because the model relies on instantaneous adjustment of the factors of production. If, for any reason, firms are slow to adjust their factors to changes in demand conditions, it would bias our markup estimates upwards. Indeed, we believe this is the case, so we do not recommend giving too much weight to the level of our markup estimates. Rather, we wish to note that the estimated time path for industrial markups is generally plausible. Thus, the decline in markups since 1991 may partly explain Finland's unexpectedly low inflation in recent years.markup; imperfect competition

Markups and Measurement Errors in Six EU Countries

This study of markups, ie prices over marginal costs in manufacturing industries, builds on the work of Robert Hall and Werner Roeger. We analyze several methods used in estimating sectoral markups, and then apply them to empirical analysis of the industrial sectors of six EU countries (Germany, France, Italy, the UK, Sweden and Finland). We argue that measurement errors in the model variables, particularly in the rental price of capital, are likely to be a major problem in markup estimation, and show that due to measurement errors, the approach developed by Roeger is likely to produce markup estimates with an upward bias. Such biased results are particularly deceiving since the outcome tends to produce artificially good fits, high t-values, and markup estimates which are "sensible" in magnitude. We also introduce a "modified" model for markup estimation, which would, if all assumptions were fulfilled and variables correctly measured, yield results identical to those obtained with Roeger's model. Yet, in contrast to Roeger's model, in the presence of measurement errors the markup estimates produced by this model have downward bias. Comparison of these two sets of estimates enables us to assess the seriousness of the measurement problem. We found that the estimates produced by the two models differed in a systematic fashion which is symptomatic of measurement errors. All in all, our results provide strong support for our hypothesis that the markup estimates obtained with Roeger's method are likely to be artifacts created by measurement errors mainly in the rental price of capital.markup; imperfect competition