Impact of Demographic Changes on Inflation in Pakistan

• Author: ATIF ALI JAFFRI, FATIMA FAROOQ AND FAISAL MUNIR

Abstract

This study empirically investigates the impact of demographic changes on inflation in Pakistan for the period 1988-2014. The study has used population growth (PG) rate and proportion of middle age working population (MAWP) as indicators of demographic change, and estimated two separate models using these proxies. Based on unit root tests, the study has applied Autoregressive Distributive Lag (ARDL) model. The findings of the study show that PG and MAWP have positive and negative impact on inflation in Pakistan, respectively. The validity of results is supported by standard diagnostic tests and results are found consistent with recent empirical evidence for other countries. No previous empirical study for Pakistan on the subject exists; thus, highlighting the contribution of this study in the literature. The study suggests that demographic factors along with traditional macroeconomic determinants of inflation must be considered for designing effective policies to control inflation in Pakistan.

Keywords: Inflation, Demographic change, Population growth, Autoregressive Distributive Lag model

1. INTRODUCTION

   Macroeconomic performance of an economy is determined through several macroeconomic indicators like inflation, growth rate, balance of payment, and unemployment rate. Controlling inflation is considered an important goal of macroeconomic policy formulation by policy makers and academia. A large body of empirical and theoretical literature is available on determinants of inflation. Empirical literature on determinants of inflation is vast showing determents range from monetary, fiscal, external and real sector variables (Ahmed et al., 2014; Bashir et al., 2011; Khan and Gill, 2010). Further, studies have confirmed that social sector variables also significantly affect inflation rate (Bhattacharya, 2014; Andersson et al., 2009; Lim and Papi, 1997). Recent literature has identified that demographic factors also affect inflation in countries experiencing demographic transition (Yoon et al., 2014; Anderson et al., 2013).

   The concept of "demographic change" refers to a population's age structure adjusting to changes in living situations (Linz and Stula, 2010). The literature suggests that working age population, growth in old age dependency, fertility rate, crude birth rate, crude death rates and population growth are frequently used indicators of demographic change (Weber, 2009).

   Studies have developed the link between the size and alignment of population structure and macroeconomic outcomes. The channels through which demographic changes affect an economy usually include savings and investment, labor market choices, aggregate demand and aggregate supply reactions. Life Cycle Hypothesis suggested that people in middle working age (40 to 64 years) are net savers while retirees and the youth are relatively more dis-savers, thus, rise in proportion of middle age working population leads toward decrease in demand-pull inflation (Imam, 2013).

   There are many empirical studies conducted to find the impact of demographic changes on inflation. Young working age population is more inflationary as compared to old working age population (Juselius and Takats, 2015). Lindh and Malmberg (2000) examine the hypothesis that net savers dump down inflation and with empirical evidence of panel study they find that population aging leads toward net saving and low inflation. On the other hand, youth population leads towards high consumption and high inflation. The same question is also addressed in recent studies which confirm a significant relationship between demographic changes and macroeconomic indicators, particularly, inflation (Yoon et al., 2014).

   Pakistan is sixth most populous country in the world and currently passing through demographic transition. Pakistan has experienced slowdown in population growth over the last four decades declining from 3.32 percent in 1980s to 1.8 percent in 2015. Age composition shows that 41 percent population is under 15 years and 3.2 percent population is above 65 years.

   Thus, 55.8 percent population is working age population, and the proportion of middle age working population (40-64 years) is 18 percent and expected to increase in coming years. The growing proportion of middle age working population has important macroeconomic implications particularly for inflation. Only few studies have investigated the implications of demogra- phic changes on macroeconomic indicators like current account balance and economic growth in Pakistan (Jaffri et al., 2012; Iqbal et al., 2015). No previous study has estimated the impact of demographic changes on inflation in Pakistan. So the current study is important to fulfill the gap in the existing literature by investigating the empirical relationship between demographic factors and inflation in Pakistan.

   In the remaining part of the paper, Section II provides review of literature and Section III discusses methodology and the results of the study. Finally, conclusion and implications of the study based on empirical findings are given in Section IV.

2. LITERATURE REVIEW

   Although theoretical literature on demographic determinants of inflation is scarce, empirical literature on the subject is growing and a large number of empirical studies for developed countries have been conducted. Stevenson (2013) explored the drivers of inflation theoretically by incorporating demographic variables in the analysis. According to the argument of the study, Life Cycle Hypothesis (LCH) is a powerful framework to understand the relationship...