Summary
– The baby boom generation has had a positive impact on asset prices in the past;
– As this generation retires and draws down its savings, the demographic effect on asset prices is expected to be negative;
– This could reduce the value of the capital accumulated by this generation for retirement;
– The use of private savings therefore appears insufficient to offset potential pension reductions if the length of working life does not increase at the same time.
The second half of the 20th century was marked in many developed countries by a major demographic phenomenon: the baby boom. As this generation begins to retire, many questions arise about the financing of public pension systems. The ratio of workers to retirees was favorable to financing a generous system when the baby boom generation was active. As this ratio is now reversing, many difficulties are arising.
Households generally save to finance their retirement beyond the pension they expect to receive in the form of various assets: stocks, real estate, bonds, or other savings products. Two major questions arise in relation to these different assets. Did the baby boom generation, when it was saving for retirement, influence their prices? What will be the impact on these prices when it starts to draw down its savings?
Demographics and asset prices: general idea
Households save a significant portion of their income between the ages of 40 and 60 in preparation for retirement, which increases demand for assets. Given its size, the baby boom generation has the potential to increase asset prices through the increased demand for savings that it generates.
When this generation begins to retire, it sells these assets, increasing their supply on the market. At the same time, as the next generation is smaller, demand for savings is lower. Higher supply and lower demand tend to reduce asset prices. For a given amount of savings, this reduces the potential consumption of baby boomers in retirement [1].
This logic obviously leaves out a number of important factors that can affect stock or real estate prices, such as changes in productivity or regulatory changes. It is also difficult to isolate the effect of a demographic phenomenon alone on asset prices. These are long-term phenomena that occur during periods when there may be numerous structural changes. As a result, there is no consensus on the impact of the baby boom on asset prices, particularly in terms of its magnitude. However, some studies tend to show that there is a relationship between asset prices and the relative size of different generations.
Demographics and asset prices: some empirical evidence
In particular, Takáts (2012), an economist at the Bank for International Settlements, used real estate prices from 22 advanced countries. His results suggest that a one percent increase in the ratio of the number of assets to the number of retirees increases real estate prices (adjusted for inflation) by two-thirds of a percentage point. It therefore appears that demographics have had a positive impact on real estate prices over the past 20 years and could have a negative impact on them in the future. Other studies, notably the comprehensive study by Geanakoplos, Magill, and Quinzi (2004) on the US stock market during the 20th century, present similar results.
However, even if we accept these results, we should not conclude that financial asset prices or real estate prices will necessarily fall. First, for the financial asset market, this may result in reversals of capital flows between aging countries and younger countries. Second, productivity or regulatory changes may affect the long-term evolution of financial and non-financial asset prices. However, demographics will undoubtedly be less conducive to significant increases in real estate prices or stock market indices, making it more difficult to finance retirement through individual savings. As with the financing of public systems, demographics do not appear particularly favorable for baby boomers in terms of private savings.
Another cause for concern is that the reversal of the ratio of working-age people to retirees has been correlated in some countries (the United States, Spain, Ireland, and Japan) with the bursting of real estate bubbles. This does not necessarily imply a cause-and-effect relationship, but it is not particularly surprising that a large number of savers may be in favor of bubbles forming. Their bursting is perhaps even more problematic when it occurs at a time when a large generation is retiring [2].
Conclusion and implications
As the baby boom generation retires and public funding of pension systems becomes more difficult, another cause for concern is that current demographics may have a negative impact on asset prices. This is likely to result in price declines or smaller increases than in the past. This makes reforms to sustain existing pension systems even more necessary. Indeed, unless agents have perfectly anticipated these effects, it is possible that private savings during working life will not be sufficient to offset potential pension declines. In both cases (public systems and private financing), we are dealing with intergenerational transfers that are influenced by the same demographic conditions.
The arithmetic therefore suggests that extending working life is essential to ensure that retirees have sufficient income. In particular, the idea that private savings could compensate for reductions in public pensions seems implausible unless it is accompanied by an increase in the length of working life. This is because the value of the capital accumulated by future retirees is subject to the same negative demographic effects that affect the financing of public pension systems.
References
– Andrew B. Abel, « Will Bequests Attenuate the Predicted Meltdown in Stock Prices when Baby Boomers Retire, » The Review of Economics and Statistics, 2001.
– Andrew B. Abel, « The Effects of a Baby Boom on Stock Prices and Capital Accumulation in the Presence of Social Security, » Econometrica, 2003.
– John Geanakoplos, Michael Magill, and Martine Quinzii , » Demography and the Long-Run Predictability of the Stock Market, » Brookings Papers on Economic Activity, 2004.
– Takáts, Előd, « Aging and House Prices, » Journal of Housing Economics, 2012.
Notes
[1] See, for example, Abel (2001 and 2003) for a theoretical model supporting this idea.
[2] See in particular the presentation by Kiyohiko Nishimura, who was deputy governor of the Bank of Japan at the time.
