Inflation through demographic change?

_ Prof. Dr. Ulrich van Suntum, University of Münster, retired Secretary-General of the Expert Council for the Assessment of Overall Economic Development. 14 January 2021. Translated by Yuri Kofner from Oekonomenstimme (ETH Zurich).*

Will the inflation rate rise because labor is becoming scarce and expensive for demographic reasons? This thesis made by Goodhart cannot be confirmed in a macroeconomic model with overlapping generations. For the price development, it is not real wages that count, but monetary development.

Recently, more real economic factors have been tried to explain inflation again. A much-discussed article by Charles Goodhart and Manoj Pradhan [1] focuses in particular on demographic developments. This has slowed inflation in the past by the baby boomers pouring into the labor markets. The unions’ ability to assert higher wages was correspondingly low. That in turn also kept the price increase within limits, since wages are the biggest cost factor. In the future, however, this trend will be reversed. In the meantime, the baby boomers are increasingly reaching retirement age, while relatively few young people grow back. As a result, the labor supply would become more expensive again in the future, and goods with them. In addition, people typically save a lot in the first phase of employment in order to provide for their old age, while older people tend to use their savings for consumption. An inflationary tendency is also derived from this because the dwindling labor force is then evidently also faced with fewer investment funds and increasing consumer demand.

Population aging in the “Viking model”

In order to test these theses, which sound plausible at first, I assumed a declining and aging population in my macroeconomic “Viking model”. This model regards the economy as a Viking village in which only grain is produced. This can either be consumed or – as seeds – invested. In the simplest version, only coins function as money.

These simplifications make it possible to intuitively understand crucial economic relationships without a lot of mathematics. Many results of the money and growth theory can be seen in the Viking village, which can also be obtained in more complex economic models. [3] In particular, demographic developments and their effects can be analyzed well with the model. There are two overlapping generations in it, the young and the old Vikings. The former work and save, while the latter consume their savings from the first phase of life. If the birth rate then falls, the proportion of those who are no longer gainfully employed in the village automatically increases, while the proportion of those in employment decreases. All behaviors are fully micro-founded, and the consistency conditions of national accounts are always met in the model.

First of all, it is correct that a shortage of young workers tends to increase wages. However, and this is where the first pitfall lies, this only affects real wages (i.e. wages in grain units in the model). In order to say something about nominal wages, we have to make additional assumptions, namely about money. Depending on whether the number of coins in the Viking village remains constant, nominal wages can rise, fall or, in borderline cases, remain completely unchanged. The same applies to the prices of goods, which, however, do not have to change completely parallel to the nominal wages. Depending on the assumption about the number of gold coins, this can indeed lead to inflationary price developments in the model, but just as well to deflation or, in the borderline case, to unchanged grain prices. The first interim conclusion is, therefore: Contrary to what Goodhart implies, a decline in the supply of jobs for demographic reasons does not necessarily mean that prices will rise.

An aging population does not necessarily lead to fewer savings

Does an aging population really mean that the economy as a whole is saving less? This is derived from the fact that there are no longer so many young and working households, which are mainly those who save. But that’s the next mistake. Because at the same time real wages are increasing, as Goodhart himself predicts. It can therefore be saved as much as before, or even more. In the Viking model, the overall economic savings rate remains unchanged. This is due to the assumed Cobb-Douglas production function, because, as is well known, the share of labor income in GDP is always the same for this production function. This also applies to the savings rate in the Viking model, because only the working Vikings save. Our second interim conclusion is, therefore: Even with an aging population, the overall economic saving rate does not need to fall, even if older people save nothing at all or even liquidate all of their assets.

With an aging population, is there still enough investment demand to absorb the savings on the capital market? This is sometimes doubted, from which a “piggy bank theory” was derived. [4] Here, too, the Viking model tells us something completely different. Because a constant savings rate with a declining population does not mean that the savings also remain at the same level in absolute terms. Rather, they are falling at the same rate that the entire economy is shrinking, as is investment. Because if fewer people live in the village next year, you will no longer need as high a harvest as before. Only the respective shares of saving, consumption, and investment in GDP always remain the same with a constant rate of contraction. So there is a steady-state equilibrium with full employment even with a negative growth rate. Of course, in reality, unlike in the ideal-typical model, this is never achieved perfectly. But conversely, demographic breaks do not necessarily lead to under- or over-saving, contrary to what is often claimed.

One can derive even more interesting effects in this context from the Viking model. For example, with a shrinking population, the per capita income tends to increase even without technical progress! This is because the constant resources such as land and mineral resources become less scarce and therefore less expensive (compared to grain) over time. How the nominal land and raw material prices develop, on the other hand, depends crucially on the money supply.

The Viking model thus supports a monetary explanation of inflation. However, this does not mean that it is based on primitive monetarism, for example, the quantity equation with a constant velocity of money. On the contrary, the price level is derived very generally and microeconomically based on money supply and demand. With this approach, one can even solve the riddle mentioned at the beginning, why prices have hardly risen despite the massive expansion of the money supply. At the same time, the demand for liquidity has increased because of the extremely low interest rates. Keynes had already seen this connection and thus justified his “liquidity trap”: Those who hardly get any interest income for long-term investments anyway keep their powder dry and, in case of doubt, store financial assets in the checking account or even in cash. Then the central bank can pump as much money into the economy as it wants, it just doesn’t make it into the cycle. This is exactly what happens with the corresponding assumptions in the Viking model, not only temporarily in imbalance as in Keynes, but also in the long-term steady state.

Is there an “avalanche of inflation” looming?

In this case, even an extremely expansionary monetary policy no longer inevitably heats up inflation. However, as e.g. H.W. Sinn recently rightly warned, [5] that the huge surplus of money is looming over us like a slab of snow and can trigger a veritable avalanche of inflation at any time. Once the prices start running, there is quickly no stopping them: The hoards of money will quickly be dissolved for fear of losing value, which will only drive inflation further. And if the central bank then desperately tries to counteract this with higher interest rates, this is long too late or possibly even counterproductive. Because the higher the interest rates, the lower the demand for money, so that inflation gets an additional boost.

The overall conclusion is therefore that declarations of inflation in the real economy may be justified in the short term but are irrelevant for longer-term developments. In fact, they are downright dangerous because they distract from the real factors in price developments. These are of monetary nature, with the amount of money determining the supply of money and the level of interest rates (as well as the price development itself) determining the demand for money. If one looks at their developments and prognoses for the next few years, one can in fact reckon with a strong loss of monetary value in the near future. Unfortunately, the Viking model does not allow quantitative or temporal forecasts, so that an exact forecast is not possible on this basis. However, this also applies to Goodhart’s theses, which are also very questionable in theory.


1  Charles Goodhart/Manoj Pradhan, The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival. Cham 2020. Vgl. Dazu auch Patrick Bernau, Kommt die Inflation bald zurück? FAZ net, aktualisiert am 16.12.2020, sowie Alexander Dilger, Inflation durch demografgischen Wandel?

2  Das Modell ist enthalten in Ulrich van Suntum, Capital, Interest, and Money, Columbia 2017, hier insbes. S. 27 ff. Es gibt dazu auch eine Excel-Datei, in der alle Modellvarianten enthalten sind und mit der man entsprechende Simulationen in einfacher Weise selbst durchführen kann (auf Anfrage kostenfrei bei mir erhältlich, bitte Mail an senden).

3  Vgl. näher dazu Ulrich van Suntum, Natural Interest Rate and Money Interest Rates, The Economist`s Voice, Jg. 2020 (im Druck),

4  Vgl. Carl Christian von Weizsäcker, Kapitalismus in der Krise? Der negative natürliche Zins und seine Folgen für die Politik. Perspektiven der Wirtschaftspolitik Jg. 16 (2015), 189–212; Carl Christian von Weizsäcker/H. Krämer, Sparen und Investieren im 21. Jahrhundert. Berlin, Heidelberg, New York 2019. Kritisch dazu: Ulrich van Suntum, Sparschwemme oder Geldschwemme – was erklärt den Niedrigzins? Wirtschaftswissenschaftliches Studium , Jg. 50 (2021) H. 3 (erscheint demnächst).

5  „Hans-Werner Sinn warnt: Inflationsblase bläht sich auf – wehe uns, wenn sie platzt“


*Translated and republished without prior written consent. For educational purposes only.

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