2nd International Forum of Collaboration Projects, Economic and Social Research Institute

Incorporating Demographic Change in Multi-Country Macroeconomic Models: Some Preliminary Results

Abstract

Demographic shifts may profoundly influence the world economy, directly in the countries experiencing the demographic change and indirectly through changes in global trade, capital markets, and exchange rates. Though that point is now widely acknowledged, it is much less widely understood that existing analytical tools are inadequate for assessing the generalequilibrium and cross-border consequences of demographic change. The research reported in this paper takes preliminary steps to improve the required analytical tools. We build on theoretical work by (among others) Blanchard, P. Weil, Faruqee, Laxton, and Symansky that suggests a revised life-cycle approach to consumption and saving behavior. We use this approach to incorporate demographic structure into open-economy empirical macroeconomic models. Changes in birth and mortality rates are combined with an approximation of age-earning profiles to allow demographic shifts to influence human wealth, consumption, and asset accumulation. Our preliminary work introduces the new approach into two simplified empirical models, a tworegion abridgement of the IMF's MULTIMOD model and a two-region abridgement of the McKibbin MSG3 multi-country model. This paper reports preliminary simulation results. The stylized shock on which we initially focus is an unanticipated and transitory demographic bulge, analogous to the "baby boom" experienced by some industrial nations several decades ago. With the passage of time, the shock results in population aging of the type now confronting industrial nations. One set of simulation results describes the effects when the demographic bulge occurs simultaneously in both of the two model regions. A second set considers the consequences when the shock occurs in one of the regions but not the other. Our preliminary findings strongly support the conclusion that this analytical approach is promising. They also strongly confirm the hypothesis that differences across countries in the timing and intensity of demographic shifts can have significant effects on exchange rates and cross-border trade and capital flows.