Population Aging and the Aggregate Effects of Monetary Policy

Abstract

This paper assesses the effects of demographic changes on the transmission of monetary policy to consumption. First, I provide empirical estimates of age-specific consumption elasticities to interest rate shocks. The consumption of the young is significantly more responsive than the national average, and drives most of the aggregate response. This is consistent with cross-state variation in demographics and estimated state-level consumption responses to interest rate shocks. Second, I develop a life-cycle model that captures these empirical facts. The model features fixed rate mortgages, with fixed costs to refinance and enter a new loan. Quantitatively, the refinancing and new borrowing decisions account for a sizable share of the difference between young and old consumption elasticities. This difference arises because the young have a higher propensity to refinance existing loans or enter new loans, following declines in interest rates. Under an older demographic structure, the model predicts a significantly lower aggregate consumption response to expansionary monetary policy shocks.

Keywords: Age structure; consumption; monetary policy; refinancing

JEL Classification: D91, E52