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More Gray, More Volatile? Aging and (Optimal) Monetary Policy

Dániel Baksa () and Zsuzsa Munkacsi ()
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Dániel Baksa: International Monetary Fund & Central European University

No 67, Bank of Lithuania Working Paper Series from Bank of Lithuania

Abstract: The empirical and theoretical evidence on the inflation impact of population aging is mixed, and there is no evidence regarding the volatility of inflation. Based on advanced economies’ data and a DSGE-OLG model - a multi-period general equilibrium framework with overlapping generations, - we find that aging leads to downward pressure on inflation and higher inflation volatility. Our paper is also the first to discuss, using this framework, how aging affects the short-term cyclical behavior of the economy and the transmission channels of monetary policy. Further, we are also the first to examine the interplay between aging and optimal central bank policies. As aging redistributes wealth among generations, generations behave differently, and the labor force becomes more scarce with aging, our model suggests that aging makes monetary policy less effective, and aggregate demand less elastic to changes in the interest rate. Moreover, in more gray societies central banks should react more strongly to nominal variables, and in a very old society the nominal GDP targeting rule might become the most effective monetary policy rule to compensate for higher inflation volatility.

Keywords: aging; monetary policy transmission; optimal monetary policy; inflation targeting (search for similar items in EconPapers)
JEL-codes: E31 E52 J11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-age, nep-cba, nep-dge, nep-mac and nep-mon
Date: 2019-09-27
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