Demographic Trends and the Transmission of Monetary Policy

This paper studies the impact of demographic trends on the transmission of monetary policy. In particular, I propose and quantify a novel channel to explain how population aging might affect the effectiveness of monetary policy and the flattening of the Phillips curve: older individuals purchase more from product categories with higher levels of price rigidity - categories which adjust their prices less often - so the aggregate frequency of price adjustment decreases as the population ages. Using micro data on consumer expenditure, I document the negative relationship between age and the frequency of price adjustment and find that it is mainly due to the higher share of services consumed by old households. At the macro level, if prices are more rigid output should respond more to monetary shocks. To test this hypothesis, I exploit the cross-sectional variation in demographic structures across the U.S. and I show that the economic activity in states with a higher old-age dependency ratio reacts more to monetary shocks. Finally, I rationalise these findings using a two-sector OLG New Keynesian model where demographic trends shift aggregate demand towards services, i.e., the stickier expenditure category. Combining the model with population projections for the U.S., I find that the changes in the age distribution between 1980 and 2010 increased the contemporaneous response of output to monetary shocks by 6% and will have increased it by 10% in 2050. Moreover, demographic trends explain around 10% of the decrease in the slope of the Phillips curve.