In his public appearances, especially aside from press conferences held regularly at the European Central Bank, ECB President Mario Draghi has often addressed the demographic challenges faced by the Old Continent. He has done so not only assuming a central banker’s point of view, but reflecting on the broader economic and social consequences of an aging and shrinking population.
First of all, according to President Draghi, raising potential growth – mainly through higher employment and productivity – is the response to a fundamental challenge posed by structural demographic change happening in Europe (in addition to other challenges, such as public debt).
In President Draghi’s words, demographic changes in our advanced economies, especially rising old-age dependency ratios, are putting more pressure on public finances. The central banker has also often mentioned the influence of an ageing population on financial markets, mainly due to permanent higher savings with all their consequences. Lastly, one must take into account the spillover effects of this new savings/investments equilibrium on the inflation objective of central bankers.
The following is a selection of the ECB President’s most salient statements on this issue.
Demography, productivity and growth
In August, during the 2017 edition of the Jackson Hole symposium, Draghi’s speech was dedicated to “Sustaining openness in a dynamic global economy”. The core idea of the speech was “openness” – i.e. open trade, investment and financial flows – as a tool for raising potential growth through productivity. International media focused of course on Draghi’s remarks on openness as the key to a dynamic global economy and on his ideas on how to make openness fair, safe and equitable, in one word “sustainable”.
The ultimate goal, that of maintaining the international economy in order to foster productivity, was instead overlooked in most media accounts, although Draghi had stated it quite clearly. He had started by saying that “at the centre of this debate is the question of how to raise potential output growth, which has slowed from around 2% in OECD countries in 2000 to around 1% today.” The lack of stronger potential growth poses a two-fold problem; in the medium term, the current cyclical recovery will converge downwards and most of all, in the longer term, “slower growth will in turn make it harder to work through the debt and demographic challenges facing many advanced economies”. If productivity has become the “leverage” of last resort, as Draghi’s sees things it is because “the population growth rate” in advanced economies is “projected to slow”.
August 25th, 2017, however, was not the first time Draghi had mentioned the existing link between a shrinking population on the one hand and productivity and growth on the other. In November 2016, marking the 100th anniversary of the Deusto Business School in Madrid, the president of the ECB stated, for example, that “in the absence of change – if output per worker, structural unemployment, and labour participation remain at current levels – population ageing will result in a stark fall of output per capita. Using the OECD’s population projections, the decline in output per head by 2050 would be 14% in Germany, 16% in Italy and 22% in Spain. While this scenario is very unlikely to materialise, it shows that current rates of productivity growth are barely sufficient to offset the demographic drag on per capita income.”
If raising potential growth is primarily all about structural reforms – as Draghi repeated during the Brussels Economic Forum in June 2016 – and if this ultimately comes down to two factors, employment and productivity, let us now consider the former. Once again, moving people from unemployment to employment, as well as a rising participation rate in the workforce, need to be the main objective of structural reforms.
“Still, despite this untapped reserve for accelerating employment growth, we cannot avoid the fact that, over time, the inherent speed limits resulting from the euro area’s unfavourable demographics will start to bite. The euro area’s working age population is projected to start gradually decreasing in the next decade. In that context, employment growth is likely to start decelerating in the not-too-distant future, even with determined structural reforms, as a higher share of people in work will no longer be able to offset the fall in working age population. Even higher expected migration is unlikely to be able to fully offset this natural population decline.”
If not even immigration – as many think – will compensate for the decline in working-age Europeans, President Draghi believes that higher productivity remains vital. In 2014, when the Eurozone recovery still needed to pick up pace, Draghi had already summarized his thinking when speaking at the Brookings Institution;
“Put simply, I cannot see any way out of the crisis unless we create more confidence in the future potential of our economies”, he said, adding that “given demographic trends, raising structural growth will have to take place primarily through productivity.”
Demography and public finances
Going back to Draghi’s speech in Jackson Hole last August, only if the demographic challenge is understood as being one of the main – maybe the most important – motivations for raising productivity through openness, can one understand what Draghi defines later in the same speech, as the most adverse effect of protectionism. “(…) A turn towards protectionism would pose a serious risk for continued productivity growth and potential growth in the global economy. And this risk is particularly acute in the light of the structural challenges facing advanced economies. Old-age dependency ratios are rising, putting more pressure on public finances. By 2025 there will be 35 people aged 65 and over for every 100 persons of working age in OECD countries, compared with 14 in 1950. At the same time, public debt levels have surged in those countries from 56% of GDP in 2007 to around 87% today. Only higher potential growth can provide a lasting solution.” “Public finances”, along with output per capita, are therefore going to suffer from an unchallenged demographic decline.
Demography and the future of financial markets
In the spring of last year, German criticism of the ECB became louder as Berlin’s Finance Minister Wolfgang Schäuble said that it was “undisputable” that “the policy of low interest rates is causing extraordinary problems for the banks and the whole financial sector in Germany”, and “that also applies for retirement provisions.” That gave Draghi one more chance to explain why a growing portion of the global economy was operating in an environment of rock-bottom interest rates.
Speaking at the Asian Development Bank’s annual meeting, in May 2016, he said “ageing” must be factored into this issue. “The drivers behind this have been, among others, rising net savings as ageing populations plan for retirement, relatively less public capital expenditure in a context of high public indebtedness, and a slowdown in productivity growth reducing the profitability of investment. One study finds such factors can account for around 400 basis points of the 450 basis points fall in long-term real interest rates over the past 30 years.”
Addressing the Eurozone with its current account surplus above 3% of GDP, and Germany in particular which has had a surplus above 5% of GDP for almost a decade, it must be noted that “in the past, countries with such surplus positions may have been able to easily export excess savings towards countries willing to borrow them at higher rates. This would have prevented domestic interest rates from falling, as would otherwise have been the case. And that would have been good for the global economy as saving flowed from ageing, slower growth economies to those with younger demographics and higher investment needs. But in a world where real returns are low everywhere, there is simply not enough demand for capital elsewhere in the world to absorb that excess saving without declining returns. So the long-term answer to raising real rates of return must be a structural rebalancing of global saving and investment. And since demographic-related saving is likely to remain high, that has to come through raising demand for capital. This is why structural reforms are so important today. They are key to raise productivity growth and hence make investment more attractive.”
Speaking at the German Bundestag in September 2016, Draghi once again challenged widespread German resentment of some ECB policies, choosing to discuss how the Central Bank’s measures affect people’s finances and welfare. He claimed that “on balance, savers, employees, entrepreneurs, pensioners and taxpayers across the euro area, including in Germany, are better off because of our actions – today and tomorrow.” Then he added that it might be wrong to focus excessively on ECB actions when it comes to explaining low rates, “After all, the interest earnings that the savers understandably crave need to be generated first in the real economy. In a stagnant economy there is little to be shared out. It should also be noted that the level to which real interest rates can eventually return when the economy strengthens is not determined by monetary policy. Instead, it depends on the economy’s long-term growth prospects. Productivity and demographics play a decisive role in this, and the development of these factors has not been favourable in Europe in recent years. This is a phenomenon we also see in Germany.”
Ultimately, the European/German demographic decline, as well as the European/German relative readiness to cope with it through productivity-enhancing structural reforms, are the prime suspects in creating a low real-interest rates environment.
Again in September 2016, this time speaking in Frankfurt-am-Main, President Draghi footnoted Lawrence Summers’s “secular stagnation” hypothesis, when he said that “long-term real interest rates have been falling in the major advanced economies for two decades. Technological change, demographics, income inequality and safe asset scarcity are just a few of the factors exerting downward pressure on long-term real rates”.
In the ECB’s Annual Report, published with a foreword by President Draghi, this position was reaffirmed, stating that “The low interest rates observed throughout 2016 were the result of global and euro area-specific factors. Some of these factors were of a long-term nature and related to structural shifts such as ongoing demographic trends and lower productivity growth, while others were associated with the deleveraging following the financial crisis and the excess of planned savings over planned investment and consumption expenditures. The accommodative monetary policy of the ECB with the primary objective of safeguarding price stability was one factor in this environment. By supporting euro area nominal growth, the ECB’s monetary policy aims to attain this objective, which should eventually lead to rising interest rates as the recovery takes hold.”
Demography, inflation and central bankers
Central banks all over the developed world are rethinking basic notions about how demographic change might affect their policies. As a matter of fact, although central bankers are not directly involved in governing the size, structure, and distribution of populations, such changes might already be influencing their mission. That is true also for the ECB, with its strict inflation mandate. Speaking at the ceremony held to mark the bicentenary of the Oesterreichische Nationalbank in Vienna in June 2016, Draghi admitted that “evidence suggests (…) that demographics-induced high savings and low productivity growth have led equilibrium real rates to fall. Aiming for 2% inflation is hence even more crucial today to get nominal interest rates safely away from the lower bound.”
It is no coincidence that in 2015 the European System of Central Banks (ESCB) set up a network of experts to study the causes of this low inflation and research implications for policy, and that such a group has already produced work directly related to demographics and inflation. In February 2016, Draghi still expressed a more cautious view on the link between demographics decline and low inflation compared to a few months later in Vienna, when he said that “even if ageing were to lead to a period of disinflation, for example through savings and investment imbalances, there is no reason why that should imply a permanently lower inflation rate.”
He did however observe that if an excess of savings would mean that the equilibrium real interest rate required to deliver price stability would be lower, then “the central bank would have to factor that into its monetary policy.” “Put another way – he concluded – the effects of ageing would call for us to adjust our instruments, but not our objectives”. Which new “instruments” was Draghi referring to? As he had already made clear in 2015, when a central bank policy runs into the constraint set by the effective lower bound for interest rates, which is not far below zero, that “increases the likelihood that we have to resort recurrently to unconventional policies to meet our mandate.”
These days, European savers may already be experiencing a small taste of what is to come for central bankers confronting an ageing society. As Bloomberg reported, summarizing a study by economists Giuseppe Ferrero and Stefano Neri of the Bank of Italy, and Marco Gross from the European Central Bank, “the rapid aging in many of the euro area’s largest countries means that rates will probably remain low even when the European Central Bank’s puts an end to the current cycle of extraordinary accommodation. In fact, nominal short-term rates could be as low as 1 percent in 2025, if the population evolves in line with current projections.” In this case, just like Draghi, some European savers too should be wary of a new foe; declining demographics.
 Elena Bobeica, Eliza Lis, Christiane Nickel, Yiqiao Sun, “Demographics and Inflation”, Working Paper Series, European Central Bank, January 2017.
 Alessandro Speciale, “After Draghi, Demography: Aging Society Will Keep Euro Rates Low”, Bloomberg News, 27th July 2017.