Demographic Structure and the Real Exchange Rate: A Study Based on Cross-Country Data
By creating a two-sector intertemporal and intergenerational small open economy model, this paper investigates how real exchange rate responds to demographic shifts in the long term. The result shows that when the capital density of tradable goods sector exceeds that of non-tradable goods sector in a country, an increase in the country’s elderly dependency rate (ODR) will cause its real exchange rate to appreciate. In addition, higher savings rate or per capita labor income means that real exchange rate is more responsive to ODR variations. We conducted an econometric test on our theoretical hypotheses using the data of 214 countries and regions during 1980-2013. Empirical result indicates that an increase of ODR will cause real exchange rate to appreciate. This result is robust and unaffected by sample grouping characteristics and differences. An increase in savings rate will significantly increase the ODR elasticity of real exchange rate. This conclusion is also significant and robust for overall samples and categorized samples (except for developed countries) and generally consistent with our theoretical hypothesis. However, our empirical research generally does not support the hypothesis that higher labor income increases the responsiveness of real exchange rate to ODR. This study is of great significance to unravel the effect of China’s ageing population on the longterm variations of renminbi’s exchange rate.
elderly dependency rate (ODR), real exchange rate, elasticity, per capita labor income, savings rate
JEL Classification Code: R23, F31, D14
Determinants of real exchange rate have been of great interest in the research of international finance. In recent years, studies on real exchange rate have been carried out from diverse perspectives, including trade difference and net foreign exchange position ( Faruqee, 1985; Philip and Gian, 2002), the productivity shocks of intermediate sectors (MacDonald and Ricci, 2005), the degree of market distortion (Rodrik, 2008) and political system ( Rogowski and Kayser, 2002). Recently, some groundbreaking
studies suggest that demographic characteristics are also an important long-term determinant of real exchange rate, including the ratio between the