Dependency ratios and inflation

In a podcast with Rob Johnson of George Soros’ Institute for New Economic Thinking, Charles Goodhart and Manoj Pradhan offer an unusual explanation for secular trends in inflation. They say that a decline in the dependency ratio creates excess supply of workers relative to consumer, putting downward pressure on prices. This trend has started to reverse, so we will see upward pressure on prices. They say that this upward pressure will become visible soon after the virus crisis is over.

Think of this in worldwide terms, with the dollar as the universal unit of account. Over the last several decades, the world labor supply rose because of population trends and the inclusion of more countries, notably China, in the world production system. The share of consumers in the population remained steady, as a decline in birth rates offset population aging by reducing the growth of young dependents.

Going forward, the labor supply will grow slowly and population aging will outpace any further decline in birth rates. So the world dependency ratio will rise, and this will put upward pressure on wages and prices.

Note that money plays no role in this story. What about “Inflation is, anywhere and everywhere, a monetary phenomenon”? Perhaps if you include the hypothesis that the real mission of the central bank is to hold down government borrowing costs, you can tell the story in a way that Milton Friedman would not object. That is, as dependency ratios were falling, there was enough worldwide saving to keep down interest rates, and central banks did not have to monetize a large share of government debt, so that inflation fell. Going forward, worldwide saving will fall, and central banks will face a dilemma. As inflation appears, they will want to stop it by raising interest rates. But if they do that, governments won’t be able to afford the interest cost on their debt, so central banks will be forced to monetize a large share of debt.

Toward the latter part of the podcast, they are asked about why markets differ from their forecast. Basically, they say that markets are extrapolating forward based on the past, in which demographic pressure on inflation was downward. It will take markets a while to realize that we are in a new regime.