Transcript Impact on financial markets

“Macroeconomic implications of
demographic developments
in the euro area”
Angela Maddaloni, Alberto Musso, Philipp Rother,
Thomas Westermann, Melanie Ward-Warmedinger
13th Economic Conference, Dubrovnik, 28 June 2007
Disclaimer: Any views expressed are only the author’s own and do not
necessarily reflect the views of the ECB or the Eurosystem
1
The current situation
 From The Economist, 14 June 2007:
“…Europe is fast becoming a barren, ageing, enfeebled place.
Vast numbers of old people, [..] will be looked after, or
neglected, by too few economically active adults, supplemented
by restless crowds of migrants. The combination of low fertility,
longer life and mass immigration will put intolerable pressure
on public health, pensions and social services, leading
(probably) to upheaval.”
 Maybe this looks a bit gloomy, but…
2
The current situation
 Available projections suggest that all Western countries face the
prospect of population ageing
 The problem is even more pronounced in the euro area, although
there are considerable differences across countries concerning
the pace of ageing
 Important consequences for economic growth, labour markets,
public finances and possibly financial markets
3
Overview
Look at the impact of population ageing for:
 Economic growth
 Labour markets
 Public finances
 Financial markets
4
Impact on growth - demographic projections
 Notwithstanding the high uncertainty surrounding population
projections, working age population growth is projected to turn
negative after 2010
2.0
1.5
working age population growth
United States
1.0
0.5
0.0
-0.5
euro area
-1.0
1950-55 1960-65 1970-75 1980-85 1990-95 2000-05 2010-15 2020-25 2030-35 2040-45
5
Impact on growth - demographic projections
 Compared to the US, euro area dependency ratio is growing much
faster. After 2050 every third person will be older than 64
60
old age dependency ratio
55
50
45
40
euro area
35
30
25
20
United States
15
10
5
0
1950
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050
6
Impact on growth – demographic projections
 The net migration rate is expected to fall up to 2010 and thereafter
to stabilise in the euro area
5
Net migration rate (1,000 population)
4
United States
3
2
euro area
1
1995-00
2010-15
2025-30
2040-45
7
Impact on growth - backward
 In the euro area the contribution of demographic factors to growth
decreased since 1980, reflecting increasing dependency ratio and a
decline in labour productivity linked to ageing
Euro area growth accounting
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
7
6
5
4
3
2
1
0
-1
-2
1965
1970
1975
1980
1985
1990
1995
2000
8
Impact on growth - backward
 Working age population growth contributed to real GDP growth
in the US more than twice than in the euro area
US Growth Accounting
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
7
6
5
4
3
2
1
0
-1
-2
1965
1970
1975
1980
1985
1990
1995
2000
9
Impact on growth – forward-scenario 1
 Assuming the labour productivity and labour utilisation evolve on
average as in the past, there will be a negative impact on euro area
growth
Euro Area Growth Accounting
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
7
6
5
4
3
2
1
0
-1
-2
1965
1975
1985
1995
2005
2015
2025
2035
2045
10
Impact on growth – forward-scenario 1
 Same scenario for the US…
US Growth Accounting
7
6
5
4
3
2
1
0
-1
-2
1965
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
1975
1985
1995
2005
2015
2025
2035
2045
11
Impact on growth – forward-scenario 2
 Assuming the labour productivity and labour utilisation grow in
line with more optimistic assumptions, still there will be a negative
impact on euro area growth
7
6
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
5
4
3
2
1
0
-1
-2
1965
1975
1985
1995
2005
2015
2025
2035
2045
12
Impact on growth – forward-scenario 2
 Same scenario for the US…
US Growth Accounting
7
6
5
Working age population contribution
Labour productivity contribution
Labour utilisation contribution
Real GDP growth
4
3
2
1
0
-1
-2
1965
1975
1985
1995
2005
2015
2025
2035
2045
13
Overview
Go through the impact on:
 Economic growth
 Labour markets
 Public finance
 Financial markets
What are the options for reforms?
14
Labour markets: current situation
 Increase labour market participation, employment, productivity: there
is significant potential for female participation…
Female participation rate
Euro area average
%
80
70
60
50
40
30
20
10
0
um
gi
l
Be
m
er
G
y
an
e
ec
e
r
G
Source: Eurostat
n
ai
p
S
ce
an
r
F
d
an
l
Ire
Ita
ly
m
xe
u
L
g
ur
o
b
s
nd
a
l
er
th
e
N
ri
st
u
A
a
l
ga
tr u
Po
F
d
an
l
in
15
Labour markets: current situation
 …and for an increased participation of 55-64 years old
%
55-64 participation rate
euro area average
60
50
40
30
20
10
0
l
Be
m
giu
Ge
ny
a
rm
ce
e
e
Gr
ain
p
S
F
ce
n
ra
Ir
nd
a
l
e
ia
ds
al
rg
r
t
n
g
u
us
rla
bo
rtu
e
A
o
m
h
P
et
xe
u
N
L
ly
Ita
F
nd
a
l
in
Source: Eurostat
16
Reform needs: labour markets
 Reduce disincentives to enter work
 interplay of taxes and benefits, early retirement schemes
 Encourage female labour market entry
 increase flexibility of working hours and provision of childcare services
 Encourage workers to remain at work later in life
 encourage policies of gradual exit from work, part-time work, increases in
statutory retirement age
 Invest in quality of education, research and development, increase
lifelong learning and tackle old age discrimination
17
Reform needs: labour markets
 The stabilisation of the old-age dependency ratios through
migration alone is unlikely, due to the large number of migrants
that would be required
 The EC states that “using migration to fully compensate the impact
of demographic ageing on the labor market is not a realistic
option”.
18
Overview
Go through the impact on:
 Economic growth
 Labour markets
 Public finances
 Financial markets
What are the options for reforms?
19
Impact on public finances
 The most important expenditure effects arise from public pension
systems and health and long-term care
 The estimated fiscal impact of the increase in pension expenditures
(from different sources) find a cumulative increase in pension
expenditure of more than 5 pp of GDP for most euro area
countries, with pressure rising rapidly after 2010 (for some
countries [GR, PT] up to 10 pp).
 Looking at the outstanding stock of pension debt, it can be
estimated an incremental implicit pension liability of close to 50%
of GDP for the four largest euro area countries.
20
Impact on public finances
 Offsetting effects through unemployment and education
expenditure are small and uncertain
 The EPC/European Commission projections may still turn out too
low (e.g. favourable assumptions re. labour productivity)
 Recent projections by the OECD point to a much more gloomy
scenario, especially concerning the cost increases of public
spending on health and long-term care.
21
Reform options: public finances
Major reform needs in public pension systems and health care and longterm care arrangements:
 Parametric reform of conventional pay-as-you-go pension systems
necessary, but most likely insufficient
 Systemic pension reform: shift part of pension financing to funded
arrangements and reduce exposure to demographic risks
 One option: notional defined contribution (PAYG) system combined with
funded pillar
 Health care: raise efficiency through setting the right incentives for
all participating parties (insurers, providers, patients)
22
Overview
Go through the impact on:
 Economic growth
 Labour markets
 Public finance
 Financial markets
What are the options for reforms?
23
Impact on financial markets
 Impact on prices and quantities due to changes in savings patterns and
savings allocations of people belonging to different generations
 Changes in financial structures linked to ongoing pension reforms
 Workers are required to save more and contribute to funded pension
arrangements
24
Impact on financial markets
 Possible changes in savings patterns are based on the idea that
wealth follows a life-cycle pattern; moreover risk tolerance
may change with age
1
1
1
1
wealth
1
future (2030)
0
current situation
0
0
0
16
20
24
28
32
36
40
44
48
52
56
60
64
68
72
76
80
age
25
Impact on financial markets
 Theoretical and empirical analysis suggests that a meltdown is
unlikely
 Forward-looking simulations results (usually based on closedeconomy assumptions)
 models suggest that current workers will earn returns around 60 basis points
below historical norm (given the assumptions in the models, this would
represent an upper bound)
 Empirical studies report ambiguous results
 results are different across countries, which would imply that the
relationship is affected by other fundamental factors
26
Impact on financial markets
Will there be an asset meltdown? Probably not, but there
could be an impact on prices:
 people may change their saving and investment behaviour (and invest more
in financial assets) especially if the benefits of public pension schemes are
significantly reduced
 international capital flows could help to smooth imbalances in domestic
capital markets (for all kind of assets?)
27
Impact on financial markets: housing
housing wealth as % of disposable income in the euro area…
500
450
400
financial wealth
housing wealth
350
300
250
200
150
100
50
0
1995 1996
1997 1998
1999 2000
2001 2002
2003 2004
2005 2006
Source: ECB estimates based on national data
28
Impact on financial markets: housing

A significant portion of households’ income
is invested in housing


the relationship between house prices and ageing remain
largely an open question; difficult to disentangle the
effect of age from other characteristics (income, marital
status, education)
Recent developments in some countries (US,
UK but also most of euro area countries)
suggest that households may treat real estate
as a source of portfolio diversification

may be risky: a future house prices meltdown?
29
Impact on financial markets: the retirement industry
Euro area households have invested their private savings more via
financial intermediaries (particularly retirement industry)
70
60
50
% savings
to institutions
in 2005
% of savings
to institutions
in 1990
40
30
20
10
0
Belgium
France
Germany
Italy
Source: Eurosystem, as a % of total financial assets
Netherlands
30
The retirement savings industry
Impact on financial markets: the retirement industry
Role played by institutional investors is expected to grow and this may
have a number of implications and possibly an impact on corporate
governance
120
Pension funds assets, as % of GDP, 2004
100
80
60
40
20
0
Belgium
Source: OECD
Germany
Italy
Japan
Netherlands
Sweden
UK
US
31
Impact on financial markets: the retirement industry

Likely increase in savings for retirement over the next decades


Portfolio allocation of pension funds likely to exert significant pressures on
financial markets


savings need to be invested and later on withdrawn to finance consumption of
elderly
possible shifts towards less risky assets as people become older?
The extent of the impact is likely to depend on the financial structure and
in particular on the social security arrangements

if countries in continental Europe shift more strongly towards funded systems,
financial asset prices could in theory show more pronounced swings related to
demographic changes
32
Impact on financial markets: the retirement industry

Shift from defined benefits to defined contributions plans


portfolio choices will be more aligned with individuals’ preferences
Revised industry regulations place more emphasis on risk
management

need to increase the supply of products to hedge against interest rate and
inflation risk




long-dated bonds
inflation-linked products
financial innovation
Instruments to hedge against longevity risks are more
problematic to develop


annuity
reverse mortgages
33
Conclusions
 Scenario analysis shows that projected demographic trends
imply a decline in average GDP growth in the euro area to
around 1% from 2020 to 2050
 It is important to implement the European Employment
Guidelines to mitigate the impact of population ageing
 Reforms of pension systems and health care arrangements are
needed to counteract pressures on public expenditures
 Impact on financial markets will derive from changes in
portfolio sizes/allocations, the likely increase in the role of
financial intermediaries and the related adjustment in the supply
of some financial instruments
34