Japan's aging population offers a roadmap for the US economy's inflation battle

Eurizon strategists said Japan's aging population provides clues to the US inflation outlook.

Xinhua News Agency / Getty Images

• Eurizon strategists forecast US inflation to steadily fall to the Fed's target of 2%.
• They point to Japan as an example of how demographic trends can alter economies over time.
• Since the 1990s, Japan's aging population has caused inflation and interest rates to fall.

While some forecasters on Wall Street anticipate inflation in the US to persist above the Federal Reserve's 2% target, Eurizon SLJ Capital suggests demographic trends in Japan says the opposite is in store for the world's biggest economy. 

Eurizon strategists Stephen Jen and Joana Freire said in a note to clients in November that Japan offers a living example of how an aging population leads to aggregate demand outpacing supply, which implies inflation globally and in the US will indeed cool off. 

In the US, the October consumer price index came in at 3.2% year-over-year, the lowest reading since June and down from 3.7% in September. 

Historical data from Japan, as well as from South Korea, Italy, and now China — a country JPMorgan has cautioned may face "Japanification" — all point to disinflation as a consequence of shifting demographics. 

"As more and more countries age, there will likely be significant implications for inflation," Jen and Freire said. "Countries will invariably fight this demographic headwind, but the end result of ageing will likely not change."

The population of Japan — the oldest economy in the world — began to meaningfully age in 1990, and since then its inflation and interest rates have dropped. Three decades of low inflation there came despite the Bank of Japan's bid to stimulate demand with unconventional monetary policy. 

"Though the bursting of the triple bubbles (equity, property, and investment bubbles) in Japan in 1990 may have had depressive effects on economic growth and inflation in the ensuing years, through balance sheet recessionary dynamics, it would be difficult to blame what happened in 1990 for what is happening now – a third of a century later," the strategists said. 

By Eurizon's calculations, Japan's labor force peaked in 2019, at 1.7 times its size from 1950, which suggests an average annual labor force growth rate of 0.77 percent a year through the expansion.

It had initially peaked in 1997, but dramatic policy efforts helped delay the ultimate peak by nearly two decades.

Similarly, China's labor force peak from 2018 will likely be pushed back by new policies. The US, meanwhile, is projected to see its labor force peak delayed due to immigration.

Eurizon's calculations of labor force peaks for China, Japan, the EU, India, and the US.

Eurizon SLJ Capital Limited

As more countries follow Japan's demographic path, inflation should follow a similar trajectory. 

Even the COVID-19 pandemic could not have altered the relationship between demographics and inflation, in Eurizon's view. Rather, the sharp drop and then gradual recovery of employment has allowed for inflation to fall without a spike in the unemployment rate.

"In the short run, we can even see some risk of outright deflation because the general price levels seem already too high," the Eurizon economists wrote. "In the long run, we see the new steady-state inflation being only marginally higher than the lows witnessed before the Pandemic."

Bank of America economists, for their part, said the latest US inflation data was a sign that the Fed's rate-hiking cycle was officially over. They believe prices would have to significantly re-accelerate for policymakers to consider raising interest rates again in 2024.

This story was originally published in November 2023.

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