Demographically Driven Inflation and Deflation

Political Calculations is quirky. On the one hand they link to Prof. Shiller's merged Cowles/S&P data (first rate scholarship/database). On the other they do a "On the Moneyed Midways" linkfest that seems aimed at a totally different target audience. Here's an example of the former:

There are two questions that we'll seek to answer in this post:

1. How might the change in a nation's population over time affect its rate of inflation?
2. Are U.S. baby boomers the most inherently evil generation ever in economic history?

Before we go any further though, for the sake of eliminating the suspense involved, here are the answers to both questions:

1. Predictably.
2. Yes.

We are being a bit facetious with our second question, but let's see if you don't draw a similar conclusion after we work through the first question.

That question arises as we've recently been looking to develop a model for anticipating the future rate of inflation in the United States, which we could then incorporate into the kind of tools we develop and make available to everybody in the world here at Political Calculations. In doing that, we began with a July 2006 paper by Ivan Kitov, a geophysicist whose work in economics we first became familiar with back in 2005 (via one of David Smith's discussion forums, whose archives unfortunately appear to only go back four years), which has intrigued us for some time: Exact Prediction of Inflation in the USA.

In the paper, Kitov presents his findings of a remarkable correlation between the measured rate of inflation observed in the U.S. and the change of the size of the U.S. workforce over the years from 1965 through 2002, which is observable in the figure we've excerpted from the paper. In this chart, we see that inflation, as measured by the GDP deflator, closely follows the trajectory determined by the change in the size of the U.S. labor force (dLF) with respect to the total labor force (LF) some two years earlier. In simpler terms, changes in the rate of inflation in the U.S lag the change in the relative size of the U.S. labor force by a two year period.

How That Might Work

How might changes in the size of the US. workforce drive changes in the U.S. inflation rate? We suspect that the answer to that question lies in the change in consumption patterns driven by those entering and exiting the U.S. labor force....MORE, including some interesting charts.