If current trends continue, the typical U.S. worker will be considerably more productive several decades from now.  Thus, one might argue that letting future generations bear the burden of population aging is appropriate, as they will likely be richer than we are even taking that burden into account.  On the other hand, I suspect that many people would agree that a fair outcome should involve the current generation shouldering at least some of that burden, especially in light of the sacrifices that previous generations made to give us the prosperity we enjoy today.

Although private and government demands for dollar assets have allowed the U.S. current account deficit and foreign surpluses to persist, these imbalances are not sustainable indefinitely. In the United States, both public and private saving will need to rise to meet the oncoming needs of an aging population. At some point, risk-adjusted returns on investments in the rest of the world will begin to look favorable relative to holding dollar assets. Dollar assets are becoming an increasing proportion of non-U.S. portfolios; this can continue for a time, but not forever. At some point, the United States is going to need to finance its imports with the proceeds of its exports, not with foreign saving.

The federal deficit should be reined in before it begins to balloon as a share of GDP reflecting demographic change. While this is not a perfect solution, and it has real near-term costs, in the end it may be the only way to engineer a gradual way out of our debt burdens.

The demographic shifts underway in the major economies seem to have contributed to an increase in demand for longer-dated fixed income assets to fund growing pension liabilities, and these shifts have been reinforced by actual and anticipated changes in the regulations that affect pension fund managers. These changes may have operated to push up the price and lower the yield on longer maturity bonds, but the effect of these changes seems likely to be small in comparison to the changes in the behavior of forward interest rates.

Putting all these factors together — slower population growth, an aging baby boom generation, the plateauing of women joining the workforce, young people’s delayed entry, and the capping of immigrant inflows — growth in our nation’s labor force will almost surely drop below 1 percent in the decade ahead, perhaps significantly so.

Currently, 3-1/4 workers contribute to the Social Security system for each beneficiary. Under the intermediate assumptions of the program's trustees, the number of beneficiaries will have roughly doubled by 2030, and the ratio of covered workers to beneficiaries will be down to about 2. The pressures on the budget from this dramatic demographic change will be exacerbated by the anticipated steep upward trend in spending per Medicare beneficiary. The soaring cost of medical care for an aging population is certain to place enormous demands on our nation's resources and to exert pressure on the budget that economic growth alone is unlikely to eliminate.

Our current, largely pay-as-you-go social insurance system...is ill-suited to address the unprecedented shift of population from the workforce to retirement that will start in 2008. 

At the Chicago Fed, we've spent a good deal of time analyzing the long-term demographic trends, and our best judgment is that we will not see a big rebound in participation. This suggests that the current low levels of labor force participation are not indicative of a slack labor market.
 

Capital flows are driven by a number of economic forces which are not fully understood, especially at a quantitative level. The “home bias” of investors, which has led them to invest in their home countries rather than seek optimal international diversification, has probably been diminishing and as a consequence investors everywhere are increasingly investing outside their home countries. Countries with rapidly aging populations, especially Japan and Western European ones, may be saving and investing in the United States against the day when their populations will be drawing down assets to support retired citizens. Because the United States economy has been growing at a faster pace than most high-income counties, investment returns from U.S. operations have tended to exceed those abroad, thus encouraging capital flows to the United States.

It is imperative that the nation come to grips with the fiscal implications of the retirement of the baby-boom generation. Creating a budget strategy and implementing policy changes to balance the federal government's budget over the long term will require hard choices, which will become more difficult the longer they are delayed.

Demographers assure us that aging baby boomers, a positive rate of family formation, and continued immigration into the U.S. are at least partially responsible for the relative rise in residential real estate prices. Economists’ best guess is that the underlying fundamentals indicate that housing markets and housing prices should begin to stabilize as the so-called conundrum fades and mortgage interest rates rise.

Demographic movements of this magnitude will require significant policy changes. The public costs of retirement systems will rise markedly unless countries raise their age of eligibility for retirement program benefits or cut these benefits. Moreover, small tax increases or benefit cuts will not do the job--the implicit actuarial deficits of these programs are so large that halfway measures will not be adequate.

The resolution of our current account deficit and household debt burdens does not strike me as overly worrisome, but that is certainly not the case for our fiscal deficit, which...will rise significantly as the baby boomers start to retire in 2008. Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances.

Examining current account balances from a demographic perspective is potentially very useful. The intertemporal approach to current account balances is well-grounded in economic theory. Saving and investment behavior are the keys to the evolution of a country’s current account. It is exactly these behaviors that the demographic perspective highlights. Moreover, the fact that many countries, especially those in the developed world, are experiencing major demographic changes suggests that additional focus from the demographic perspective is warranted.

It is clear that Japan and Europe face imminent demographic challenges. Thus, it is natural that they accumulate claims against a country that has financial markets and economic growth prospects of sufficient magnitude to facilitate the required adjustment process. A case can be made that the current account surpluses of these countries as well as the current account deficits of the United States will be reversed in the future as these aging economies draw on their claims against the United States.