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Declining Trends in the Real Interest Rate and Inflation: Role of aging

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  • FUJITA Shigeru
  • FUJIWARA Ippei

Abstract

This paper explores a causal link between the aging of the labor force and declining trends in the real interest rate and inflation in Japan. We develop a new Keynesian search/matching model that features heterogeneities in age and firm-specific skill levels. Using the model, we examine the long-run implications of the sharp drop in labor force entry in the 1970s. We show that the changes in the demographic structure driven by the drop induce significant low-frequency movements in per-capita consumption growth and the real interest rate. They also lead to similar movements in the inflation rate when the monetary policy rule follows the standard Taylor rule, failing to recognize the time-varying nature of the natural rate of interest. The model suggests that the aging of the labor force accounts for roughly 40% of the decline in the real interest rate observed between the 1980s and 2000s in Japan.

Suggested Citation

  • FUJITA Shigeru & FUJIWARA Ippei, 2015. "Declining Trends in the Real Interest Rate and Inflation: Role of aging," Discussion papers 15140, Research Institute of Economy, Trade and Industry (RIETI).
  • Handle: RePEc:eti:dpaper:15140
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    File URL: https://www.rieti.go.jp/jp/publications/dp/15e140.pdf
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    References listed on IDEAS

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    1. Ikeda, Daisuke & Saito, Masashi, 2014. "The effects of demographic changes on the real interest rate in Japan," Japan and the World Economy, Elsevier, vol. 32(C), pages 37-48.
    2. Fujiwara, Ippei & Teranishi, Yuki, 2008. "A dynamic new Keynesian life-cycle model: Societal aging, demographics, and monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2398-2427, August.
    3. Lin, Ching-Yang & Miyamoto, Hiroaki, 2012. "Gross worker flows and unemployment dynamics in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 26(1), pages 44-61.
    4. Ferrero, Andrea, 2010. "A structural decomposition of the U.S. trade balance: Productivity, demographics and fiscal policy," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 478-490, May.
    5. Mitsuru Katagiri, 2012. "Economic Consequences of Population Aging in Japan: Effects through Changes in Demand Structure," IMES Discussion Paper Series 12-E-03, Institute for Monetary and Economic Studies, Bank of Japan.
    6. Mikael Juselius & Elod Takats, 2015. "Can demography affect inflation and monetary policy?," BIS Working Papers 485, Bank for International Settlements.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Declining Trends in the Real Interest Rate and Inflation: Role of aging
      by Christian Zimmermann in NEP-DGE blog on 2016-01-13 21:54:25

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    Cited by:

    1. Sasaki, Yuri & Yoshida, Yushi, 2018. "Decomposition of Japan's trade balance," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 507-537.

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