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Demographics and inflation in the euro area: a two-sector new Keynesian perspective

Author

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  • Lis, Eliza
  • Nickel, Christiane
  • Papetti, Andrea

Abstract

Can the aging process affect inflation? The prolonged decline of fertility and mortality rates induces a persistent downward pressure on the natural interest rate. If this development is not internalized by the monetary policy rule, inflation can be on a downward trend. Using the structure of a two-sector overlapping generations model embedded in a New-Keynesian framework with price frictions, calibrated for the euro area, this paper shows that following a commonly specified monetary policy rule the economy features a ”disinflationary bias” since 1990, in a way that can match the downward trend of core inflation found in the data for the euro area. In this model, continuing to follow the same rule makes inflation to be on a declining pattern at least until 2030. At the same time, changing consumption patterns towards nontradable items such as health-care generate a small ”inflationary bias” a positive deviation of inflation from target of less than 0.1 percentage points between 1990 and 2030. In the model setting of this paper, this inflationary bias is not strong enough to counteract the disinflationary bias generated by the downward impact of aging on the natural interest rate. JEL Classification: E43, E52, E58, J11

Suggested Citation

  • Lis, Eliza & Nickel, Christiane & Papetti, Andrea, 2020. "Demographics and inflation in the euro area: a two-sector new Keynesian perspective," Working Paper Series 2382, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202382
    Note: 166869
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    References listed on IDEAS

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    Cited by:

    1. Koester, Gerrit & Lis, Eliza & Nickel, Christiane & Osbat, Chiara & Smets, Frank, 2021. "Understanding low inflation in the euro area from 2013 to 2019: cyclical and structural drivers," Occasional Paper Series 280, European Central Bank.
    2. Reichold, Karsten & Wagner, Martin & Damjanovic, Milan & Drenkovska, Marija, 2022. "Sources and Channels of Nonlinearities and Instabilities of the Phillips Curve: Results for the Euro Area and Its Member States," IHS Working Paper Series 40, Institute for Advanced Studies.
    3. Bodnár, Katalin & Nerlich, Carolin, 2022. "The macroeconomic and fiscal impact of population ageing," Occasional Paper Series 296, European Central Bank.
    4. Giacomo Mangiante, 2022. "Demographic Trends and the Transmission of Monetary Policy," Cahiers de Recherches Economiques du Département d'économie 22.04, Université de Lausanne, Faculté des HEC, Département d’économie.

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    More about this item

    Keywords

    consumption composition; euro area; inflation; monetary policy; population aging;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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