Aging, Savings, Inflation And Real Effective Exchange Rate

Previous studies on Exchange rate mainly focused on the impact of savings, investment, capital flows and other economic variables. In recent years there has been a growing interest in the effects of population challge on the real (effective) exchange rate (REER). These studies, which conclude aging will bring REER appreciation, are mainly based on the Life Cycle Hypothesis (LCH)-that is Current Account Effect and Demand Structure Effect, i.e., ignoring Supply Effect.Employing a large sample of 187 countries for the years 1980-2009, we find strong evidences that the social savings diminish significantly as the population aging increases. The strong effects of population aging on inflation, too, are examined in a panel of 151 countries for the years 1971-2010. Then we find an increase in the population aging is associated with a real effective appreciation by using a log linear regression equation. However, we also show that Supply Effect plays an essential role on the effect of population aging on REER, after adding a quadratic term of population aging variable in the benchmark model.This paper draws two conclusions:(1) Population aging will have a stronger influence on country’s real effective exchange rate, if there is a more dependence of its economic growth on labors. (2) The decline of labor productivity growth can be offset by introducing advanced technology and (or) adjusting domestic industrial organization, however, serious population aging is bound to have a negative impact on labor-productivity, bringing a depreciation pressure on its real effective exchange rate in a long run.