Interest Rates and Monetary Policy Implications in an Ageing Economy

Abstract

This working paper is written by Hongyi Chen (Hong Kong Institute for Monetary and Financial Research) and Jingyi Zhang (Shanghai University of Finance and Economics).

Declining birth rates and increasing life expectancy have resulted in rapid population ageing worldwide. We study the impact of these demographic shifts on interest rates using a New Keynesian life-cycle model, which introduces overlapping generations with a defined childhood period. We find that increased life expectancy depresses interest rates through higher precautionary savings and labour shortages. In contrast, declining birth rates lower steady-state interest rates but temporarily raise them as workers consume more in anticipation of future labour shortages and wage increases. Cross-country data confirms these contrasting effects. Our findings suggest that population ageing calls for immediate interest rate cuts when driven by rising life expectancy, but a delayed cut when driven by declining birth rates.

Keywords: Population ageing, interest rates, monetary policy, inflation