Aging and the Macroeconomy Long-Term Implications of an Older Population (2012) / Chapter Skim
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8 Capital Markets and Rates of Return
8 Capital Markets and Rates of Return
Pages 153-173
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From page 153... ...
As discussed in Chapters 5 and 7, the returns earned by participants in DC plans, along with their contributions, determine their asset balances at retirement and directly affect postretirement living standards. In DB plans, the links between asset returns and participant benefits are weaker, since the firm or government offering the pension plan bears the risk of asset value fluctuations.
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From page 154... ...
However, that scenario seems unlikely because it is inconsistent with forward-looking behavior on the part of financial market participants; it would require a sharp fall in asset prices in response to a predictable demographic event. This chapter examines the ways in which prospective changes in the age structure of both the United States and the global population may af
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From page 155... ...
Because other factor inputs, notably labor input, also affect asset returns, the committee also explores how changing population age structure may affect labor supply and the decisions of young households with regard to human capital acquisition. Rising investment in human capital by younger workers can potentially offset some of the rate of return consequences associated with population aging, since the effective labor supply from a small cohort of highly skilled workers can be comparable to that from a larger cohort of less-skilled workers.
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From page 156... ...
Migration of assets tends to equalize expected returns internationally: The global supply and demand for assets determines expected returns.
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From page 157... ...
While the committee focuses on the mobile assets case, if asset mobility is limited, then while global population dynamics may affect rates of return, domestic demographic factors may also matter. Table 8-1 shows the evolution of the U.S.
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From page 158... ...
For a given level of expected returns, the desire to smooth consumption over time causes households to hold higher levels of savings when they expect consumption growth to be relatively slow; conversely they save less or try to borrow against future income when expected consumption growth is more rapid. Impatient households postpone the accumulation of savings until they near retirement age.
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From page 159... ...
The foregoing discussion of the effect of population aging on household savings therefore is suggestive of the forces that will indirectly affect corporate savings as well. Governments save when current-year tax revenues exceed current-year spending, i.e., when they run budget surpluses.
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From page 160... ...
Asset Market Equilibrium and Expected Returns Expected rates of return shift over time so as to equalize the supply of and demand for savings. The foregoing discussion underscores the many factors that influence supply and demand and their interactions with an aging population.
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From page 161... ...
Earlier chapters of this volume examine how the choice between such alternatives may be affected by population aging. From a macroeconomic perspective, a key question is to what extent an aging population will affect the aggregate risk appetite of the capital market.
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From page 162... ...
Empirical and Simulation Evidence on Demographic Structure and Rates of Return To address the quantitative effect of population aging on rates of return, a number of studies have compared historical returns on financial assets in different time periods or different countries that were characterized by different population age structures. Other studies have used simulation models that incorporate the supply and demand elements that were described above to analyze the size of these effects.
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From page 163... ...
Empirical Analyses of Past Returns and Demographic Structure Data on population age structure and rates of return, both over time in individual countries and across nations, can be used to examine the correlation between demographic factors and asset market returns. While several studies identify a strong relationship between a particular measure of demographic structure and a particular set of asset market returns, others find little or no association.
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From page 164... ...
Simulation Evidence The simulation literature on the effects of changing demographic structure has included studies of a single economy, best interpreted as representing the global economy with fully integrated capital markets, as well as studies that recognize the different current and prospective demographic structures of various regions of the global economy. Most studies consider a single asset category, which can be thought of as all capital invested in productive uses.
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From page 165... ...
In such an integrated global financial market, when the aging population in one nation leads to a rising supply of savings and in the associated physical capital:labor ratio in that country, households can invest in other nations and take advantage of the lower capital:labor ratio elsewhere to earn a higher return than the one that would be available if the domestic economy was an isolated entity. If the population of a small, "open" economy grows old but the rest of the world has a stable age profile, there may be very little if any effect on the rate of return earned by its residents -- by investing abroad, they can continue to earn the prevailing global rate of return.
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From page 166... ...
The recent experience underscores that other factors, such as cross-national differences in underlying saving rates, can play key roles. Prospective changes in social insurance programs in some developing nations could alter the demand for precautionary saving in those nations, thereby affecting their national saving patterns and financial flows.
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From page 167... ...
"HUMAN CAPITAL DEEPENING": HOW MUCH OFFSET TO LABOR FORCE DECLINE? The foregoing discussion of how population aging affects the labor force treated the age-specific pattern of labor market activity as fixed, even though there are a number of margins on which adjustment is possible.
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From page 168... ...
Such human capital deepening would raise the marginal physical product of capital. As economically important developing nations that are well integrated with the global economy, such as China and India, embark on growth paths with rapidly growing educational attainment, they will play an increasingly important role in determining the global capital:labor ratio.
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From page 169... ...
That research suggested that an aging population would lead to lower housing demand and falling house prices.2 While the two decades since that analysis have drawn attention to many other factors that may affect housing markets, a feature that distinguishes owner-occupied housing from stocks, bonds, and many financial assets is that it must be owned domestically. This results in a tighter linkage between a nation's population age structure and the level of demand for such housing than, for example, between its age structure and the demand for corporate equity claims.
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From page 170... ...
Some asset classes may be affected more than others. For example, owneroccupied housing in areas with rapidly aging populations may experience a decline in values, while land in the central business district of cities with rapid population inflows may rise in value.
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From page 171... ...
Hence the forces of supply and demand for capital cause the expected return on any incremental unit of physical investment -- the "marginal physical product of capital" -- to equal the expected return on financial assets. The prices of existing financial and physical assets also adjust so that expected rates of return are equalized across investments.
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From page 172... ...
This puts upward pressure on asset prices and lowers expected returns, thereby encouraging greater investment in physical capital. In the foregoing example of a machine, if the expected rate of return were to fall unexpectedly from 5 percent to 4.5 percent, then the price of existing machines would immediately increase from $200 to $222 (= $10/.045)
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From page 173... ...
CAPITAL MARKETS AND RATES OF RETURN 173 TABLE 8-A-1 Illustrative Price Path Needed to Provide Investors with Their Required Return Elapsed Number of Years Price of Machine (dollars)
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