Macro Roundup

Adrien Auclert, Hannes Malmberg, Frederic Martenet and Matthew Rognlie, "Demographics, Wealth, and Global Imbalances in the Twenty-First Century," National Bureau Of Economic Research, August 2021, https://www.nber.org/papers/w29161

Note Appendix F squares findings with existing results, “…we show that our results are useful to understand existing findings in the literature. First, across papers that conduct a similar exercise, we trace results back to their inputs, and show why different assumptions about the compositional effect are a critical driver of the differences in general equilibrium outcomes. Second, within papers that consider the role of parameter changes, we show that our results are useful in explaining the functional form relationship between these parameters and general equilibrium outcomes. In the interest of space, we focus on the effect of demographic change on the total return r (sometimes referred to as the natural interest rate, or r∗, in the literature)…”

"...One key observation in this literature is that the savings rate is hump-shaped in age, so that as the population continues to age, the aggregate savings rate eventually declines. Observers have made various macroeconomic predictions based on this effect: that aging will raise interest rates...decrease standards of living by impairing capital accumulation....or exert inflationary pressure as the number of consumers increases relative to the number of producers (Goodhart and Pradhan 2020). These predictions are not borne out in our analysis. Instead, we find that aging unambiguously lowers the real interest rate, thereby increasing capital intensity and output. A lower real interest rate also implies less inflationary pressure in any standard model in which this pressure is captured by the natural interest rate..... Figure 9 shows the resulting projected savings rates until 2100. These are indeed negative in all countries. In panel A of figure 10, which represents steady-state equilibrium between savings and investment, we depict this effect as a leftward shift in the private savings curve. At first glance, this might seem to imply an increase in r, as represented by the hollow circle. But since demographic change lowers the population growth rate and therefore g, the other curve—representing net investment and public borrowing—also shifts left, and the overall effect is a decline in r.To understand this result, it is useful to compare to panel B, which depicts steady state equilibrium between asset demand and supply. Here, only the asset demand curve shifts—to the right—and the unambiguous implication is a decline in r. But the curves in panel A are identical to panel B, just both multiplied by g. Hence, although both curves in panel A shift left, the net investment curve shifts left by more, producing the same decline in r as in panel B. We conclude that the “flow” view of equilibrium in panel A is in principle just as valid as the “stock” view of equilibrium in panel B, but only if we remember the effect of g on net investment. Ignoring this effect in the context of demographic change, which can significantly push down long-run g, may give the wrong sign for the change in r..."

".. .Table 1 presents our results. The left-hand panel shows the changes in the rate of return, calculated using equation (13), while the right-hand panel shows the average change in log wealth-to-GDP in percent, calculated using equation (14). We find that the equilibrium return r unambiguously falls in response to demographic change, refuting the “great demographic reversal” hypothesis...In our central scenario, r falls 123 basis points by the end of the twenty-first century; the fall is larger when σ or η are small, since this limits the responsiveness of asset supply and demand to falling returns. For our central scenario, average wealth-to-GDP increases by 10%, or approximately 47 percentage points in levels as a share of GDP..."

"...Next, we turn to the evolution of net foreign asset positions. Figure 6 shows the changes between 2016 and 2100 predicted by the formula in proposition 3. The bars display the main results, which feature a large divergence in NFA positions, with India and China experiencing increases of 44 to 125 percentage points and Germany experiencing a decrease of 55 percentage points.... Panel A of figure 7 implements this calculation. The solid lines show global imbalances until today for the five large economies discussed in the introduction, and the dashed lines show the projections from equation (25). In the next few decades, we expect to see a widening of existing global imbalances: China’s net foreign assets will rise substantially, while those of the US will decline. Although these trends flatten mid-century, the second half of the 21st century features a conspicuous rise in India’s net foreign assets, offset partly by a decline in Germany and Japan, whose demographic transitions at that point are nearly complete...."

"...The main mechanisms are summarized in figure 4. The grey bars show the evolution of the population distribution, starting young in 1950 and growing progressively older over time. In the figure, this population evolution is superimposed with the 2016 profiles of assets and labor income, with panel A illustrating how demographic change pushes up assets by moving individuals into high asset ages, and panel B illustrating how demographic change first pushes up aggregate labor income as the baby boomers reach middle age—the so-called “demographic dividend” (Bloom et al., 2003)—and later pushes down aggregate labor income as more individuals reach old age...Figure 5 displays the evolution of ∆ comp,a t and ∆ comp,h t (multiplied by W0/Y0 to obtain level effects on wealth-to-GDP).24 Panel A shows that ∆ comp,a t monotonically pushes up the wealth-to-GDP ratio throughout the sample period. The trend flattens towards the end of the 21st century as aging becomes concentrated in very old ages where asset accumulation ceases. However, the trend never reverses, due to the well-known fact that asset decumulation in old age is very limited....For other countries, the logic behind ∆ comp is broadly similar to that for the United States..."

The compositional effect of demographics

“…The results from this calculation are displayed in figure 2. Between 1950 to 2016, the compositional effect is positive in all countries, with an average increase of 80pp of GDP, and an increase of 105pp in the United States. These effects are quantitatively large. As a point of comparison, the actual changes in W/Y that occurred over this period were 220pp for the average country with available data in the WID, and 118pp for the US. Looking ahead from 2016 to 2100, the effects remain positive, are even larger on average, and are heterogeneous across countries, ranging from 48pp in Hungary to 237pp in China and 327pp in India, with a 147pp increase in the United States. In the high fertility scenario, the effect is reduced by a younger population: it is brought down to 75pp in China and to 142pp in the United States; in contrast, the low fertility scenario sees even sharper aging, and the effect swells to 245pp in the United States and 447pp in China. Figure 3 provides more detail on the heterogeneity across countries, with the solid bars displaying the predicted compositional change in W/Y to 2100 for the main population scenario. In principle, this cross-country heterogeneity could reflect either differences in demographic evolution or differences in the age profiles of assets and labor income. While both matter, the former is the main factor: countries with large effects are those whose demographic transitions are later and faster. The transparent bars in figure 3 illustrate this by showing similar cross-country heterogeneity in compositional effects if we counterfactually assume that all countries have the same asset and income profile as the United States...."

they note the impact of government debt can change this underlying dynamic, “…Although our baseline exercise holds government debt-to-GDP policy fixed, we show how rising government debt can mitigate or even undo the effect of demographic change on real interest rates, while increasing the effect on wealth-to-GDP…Since we have no direct way to predict the effect of demographics on long-run government debt targets, propositions 2 and 3 both assume a benchmark where each country keeps long-run debt-to-GDP constant. Appendix B.4 discusses alternative settings where debt-to-GDP changes in response to demographics. Two special cases stand out: when each country increases its debt-to-GDP target by the amount of its compositional effect, and when each country increases debt-to-GDP by the average world compositional effect. In the first case, there is no change in interest rates or net foreign assets, and each country’s wealth increases by exactly its compositional effect. In the second case, the same conclusions hold for interest rates and wealth, but net foreign assets in each country increase by the difference between its compositional effect and the global average, leaving the global imbalances predicted by proposition 3 intact….”

new Rognlie argues that Goodhart and Pradhan are wrong, there won't be a "great demographic reversal." He projects out the compositional effect of aging on the wealth-to-GDP ratio of 25 countries for the remainder of this century, bottom line"...According to our model, this will lead to capital deepening everywhere, falling real interest rates, and rising net foreign asset positions in India and China financed by declining asset positions in the United States. Our approach, based on stocks rather than flows, shows why there will be no great demographic reversal...."
"....we refute the great demographic reversal and show that, instead,demographics will continue to push strongly in the same direction, leading to falling rates of return and rising wealth-to-GDP ratios. We find that the key force is the compositional effect of an aging population: the direct impact of the changing age distribution on wealth-to GDP, holding the age profiles of assets and labor income fixed.In a baseline overlapping generations (OLG) model, this is a sufficient statistic for the actual change in wealth-to GDP for a small open economy. Further, for a world economy, the compositional effect— when aggregated across countries, and combined with elasticities of asset supply and demand that we obtain with other sufficient statistic formulas—fully pins down the general equilibrium effect on wealth-to-GDP, asset returns, and global imbalance..."

"...We measure the compositional effect by combining population forecasts with house-hold survey data from 25 countries over the period 2016-2100. We find that it is positive and large everywhere, but also heterogeneous, ranging from an increase in wealth-to GDP of 48pp in Hungary to 327pp in India. Since the average effect is positive and large, our model shows that there will be no great demographic reversal:through the twenty first century, population aging will continue to push down global rates of return, with our central estimate being -123bp, and push up global wealth-to-GDP, with our central estimate being a 10% increase, or 47pp in levels.Since the effect is heterogeneous across countries, our model predicts that demographics will also generate large global imbalances. For instance, we find that India’s net foreign asset position will steadily grow until it reaches 100% of GDP in 2100, while the United States’s net foreign asset position will decline to absorb this demand for assets...."

".. The average share of the population above 50 years of age has increased from 15% to 25% since the 1950s, and it is expected to rise further to 40% by the end of the twenty-first century(Figure 1, Panel A). There is a widespread view that this aging process has been an important driver of three key macroeconomic trends to date. According to this view, an aging population saves more, helping to explain why wealth-to-GDP ratios have risen and average rates of return have fallen (Figure 1, Panels B and C).1 Insofar as this mechanism is heterogeneous across countries, it can further explain the rise of global imbalances..."

"...In 1986, workers’ median weekly earnings jumped nearly 16% when they moved into that age bracket from their 20s and early 30s, according to BLS data. In 2005, as the oldest members of Gen X crossed the same age threshold, workers’ median weekly earnings increased by 20%. In 2020, workers saw a 22% increase in income when transitioning from the 25-to-34 age bracket to 35 to 44, which means older millennials entering this age range this year are on track to notch similar increases in income...."

Julia Carpenter, "Millennials’ High-Earning Years Are Here, but It Doesn’t Feel That Way,"Wall Street Journal, August 12, 2021, https://www.wsj.com/articles/millennials-high-earning-years-are-here-but-it-doesnt-feel-that-way-11628769603

Millennials’ High-Earning Years Are Here, but It Doesn’t Feel That Way

The oldest millennials are approaching a new money milestone: their high-earning years.

After two recessions and a world-changing pandemic, the arrival of the high-earning years for millennials born in the 1980s are around the corner. Yet data suggest this phase of life might not provide the financial security other generations found at the same age.

With a higher debt-to-income ratio and other financial obligations already pressing on their budgets, some millennials entering their high-earning years have delayed homeownership and family formation, said Lowell R. Ricketts, a data scientist for the Institute for Economic Equity at the Federal Reserve Bank of St. Louis.

“In perspective, you can kind of understand how the millennial generation is a microcosm of the K-shaped recovery that we’re seeing and also just the divergence in wealth overall,” Mr. Ricketts said. “I think you have to factor in the labor market changes over time as well, but there’s a kind of more of a sense of insecurity, even though you might be now earning a high salary or wage, that might not be guaranteed tomorrow.”

Workers hit their peak median weekly earnings between the ages of 35 and 54, according to the Bureau of Labor Statistics. After that period, individual earnings typically decrease or plateau, but workers experience the greatest gain in earnings when they jump from the 25-to-34 to the 35-to-44 age bracket.

Those high-earning years coincide with the time when many adults take on new financial responsibilities such as a mortgage or child care or elder-care costs. While every generation complains about higher costs nibbling their earnings, millennials may feel particularly squeezed as they juggle a high debt-to-income ratio and try to catch up on delayed life events, according to data.

As of 2020, the median age of a first-time home buyer was 33 years old, up from 30 years old a decade ago, according to the National Association of Realtors. Americans are also waiting longer to become parents: According to the Centers for Disease Control and Prevention, the mean age of mothers at first birth was 27 in 2019, a record high.

Older millennials in their high-earning years are also still working to recover lost ground from previous bouts of unemployment or underemployment caused by the 2008 financial crisis, according to a 2020 study from the National Bureau of Economic Research.

“You carry that with you for a long time, maybe your whole career,” said William Gale, one of the authors of the study and a senior fellow in the Economic Studies program at the Brookings Institution.

The study—which examined household wealth across generations using data from the Survey of Consumer Finances, a survey conducted every three years by the Federal Reserve—found that the 2007-09 recession significantly reduced wealth for all age groups, and younger cohorts in particular. In 2016, millennial households held around 12% less wealth than did households headed by a person of the same age in 1989.

In 2019, the Federal Reserve Bank of St. Louis found older millennials’ debt-to-income ratios to be 23% higher than expected, based on previous generations at similar ages.

The overall real average wage of 2018 had the same purchasing power as it did 40 years ago, Drew DeSilver, a senior writer at Pew Research Center, wrote in an article. That means despite the strong gains in earnings and a growing post-pandemic labor market, many millennial households may not see more flexibility in their budgets, according to Mr. DeSilver.

“The extra money I make every year just gets funneled into something new, in the necessary things in our life,” said Andrea Pica, a 39-year-old working in pharmaceutical operations living in Neptune City, N.J. “Daycare is like a mortgage payment,” she added.

Ms. Pica began making more money in her mid-30s and recently crossed a personal income goal. She said the extra money she already made didn’t dramatically change her lifestyle. A large chunk of it instead went to pay for care for her first child, then her second.

According to the federal Consumer Price Index, the cost of child care and nursery school has risen at roughly twice the pace of inflation since 2000.

To some extent, financial stress might be a millennial generational trait. In a recent 2021 Deloitte poll of nearly 15,000 millennials and more than 8,200 members of Generation Z on the topics related to the pandemic and economy, 41% of millennials reported they feel stressed all or most of the time, and two-thirds of that group agreed their personal finance situations contribute to that worry.

Tim Eng, a 35-year-old product manager based in Colchester, Conn. said he, along with most of his friends and neighbors, has also reached personal salary goals, but those higher levels of pay also come with a cost: longer hours and more stress.

“You’re not going to make more income without drastically uprooting your life,” he said. “It’s about making the most of what they have.”

He said the pandemic has refocused his goals for this high-earning period. Now, Mr. Eng said he is aiming to save more money with the goal of one day retiring early or reducing his working hours so he can spend more time with his family.

Ms. Pica said she’s unsure how other people her age will handle rising housing and living costs.

“You just kind of have to figure it out, and I think sometimes that could even be an added level of stress, especially for those that are not high-income earners yet,” she said.

With plenty of job openings and baby boomers retiring, career advancement should help millennials with earnings. In the third quarter of 2020, about 28.6 million boomers reported they were out of the workforce because of retirement, according to a Pew Research Center analysis of monthly labor force data.

Yet labor-force participation for workers over 60 has increased, according to data from the Bureau of Labor Statistics. Boomers’ decisions to work longer could stall some career advancement for Gen X and millennial workers, said Mr. Ricketts of the Federal Reserve Bank of St. Louis.

“Gen X can’t move up to senior positions currently held by boomers, and then millennials can’t move up to their positions,” he said. “The broad numbers point to a challenge in that narrative that ‘baby boomers are done and setting sail on their boats to go fishing.’ This is really a story of folks still working.”

"Science and innovation are central to human progress and national economic success. Currently, the United States invests 2.8% of GDP in research and development, which is supported by a range of public policies. This paper asks whether the United States invests enough. To answer that question, the conceptual case for government intervention and skepticism about that case are reviewed. The paper then turns to systematic evidence, including the very latest evidence, regarding the operation of the science and innovation system and its social returns. This evidence suggests a clear answer: We massively underinvest in science and innovation, with implications for our standards of living, health, national competitiveness, and capacity to respond to crisis."

Benjamin Jones, "Science and Innovation: The Under-Fueled Engine of Prosperity," Aspen Economic Strategy Group, July 14, 2021, https://www.kellogg.northwestern.edu/faculty/jones-ben/htm/Science%20and%20Innovation%20_%20Underfueled%20Engine%20of%20Prosperity.pdf

Spending, “…United States has faced a slowdown in productivity growth and rising concern about the international competitiveness of the U.S. workforce over many years (e.g., Gordon 2012; Autor et al. 2013), where real wages for the median household have struggled to rise and failed to keep pace with the gains in prior generations (e.g., Council of Economic Advisers 2011; Autor et al. 2006). Yet, even as productivity has lagged, U.S. R&D intensity has slipped compared to other countries. In the mid-1990s, the United States was in the top five of countries globally in both total R&D expenditure as a share of GDP and public R&D expenditure as a share of GDP (Hourihan 2020). Today, the United States ranks 10th and 14th in these metrics, and U.S. public expenditure on R&D as a share of GDP is now at the lowest level in the last 60 years. See figure 5 for U.S. trends. By contrast, China has massively increased its science and innovation investments in pursuit of leading the world economically and strengthening its hand in global affairs. China’s R&D expenditure has grown 16% annually since the year 2000, compared to 3% annually in the United States. If China implements its current five-year plan, it will soon exceed the United States in total R&D expenditure….”

Range of estimates of social return to R&D spending