Monetary Policy Goes Boomer: The Effect of Population Age Structure on Policy Transmission

How does the population age structure affect monetary policy? With advanced economies experiencing increased inflation risk and sluggish growth, it is more important than ever to understand how the monetary toolbox transmits to the outcomes that policymakers wish to affect. Studying a long run panel of countries, we identify the impact of changing population age structures on the effectiveness of monetary policy transmission to the economy. These shocks are identified using a recently proposed trilemma instrument for quasi-exogenous change in policy rates. On the one hand, we provide strong empirical evidence for a relationship between age structure and the transmission of interest rate shocks to CPI inflation, with young populations reducing this transmission, middle-aged ones reinforcing it, and older retirees strongly reducing it again. We observe the same pattern for nominal wages and real house prices. On the other hand, population aging is found to have transitory effects on the responsiveness of real aggregate variables such as, output, consumption, and investment with older populations delaying the impact of monetary policy. We find no impact on transmission to unemployment. These results have potentially important implications for the conduct of policy, particularly in the current environment where central bankers must frequently choose between their inflation and full employment targets.