kazumasa iwata : japan ’ s economy under demographic changes summary of a speech by mr kazumasa iwata, deputy governor of the bank of japan, at the australiajapan economic outlook conference, sydney, 7 december 2004. the references can be found on the bank of japan ’ s website. * 1. * * introduction japan is one of the most rapidly ageing countries in the world. the ageing process has been promoted by a lower fertility rate, preceded by a lower mortality rate and a higher life expectancy. this pattern is common to the ageing process in other countries. the higher life expectancy reflects improved living conditions, and thus can be regarded as a success in terms of economic development. it also implies the market expansion of new services for the elderly. on the other hand, the lower fertility rate implies a diminishing market size due to the decreasing population, if it falls below the threshold of the reproduction rate, which is 2. 1. the ageing process brings about not only a sharp increase in the dependency ratio, but also a sharp decline in the working - age population as well as the total population. the total population is forecast to peak at 128 million in 2006 and decline to 100 million in 2050. it will diminish to about 40 percent of the current size in 2200, with aged persons above 65 years old exceeding 30 percent of the total population. japan thus faces two problems : not only an increase in the proportion of retired elderly people, but also a decreasing population. the share of the working - age population had already peaked out in the early 1990s. furthermore, if in the future the fertility rate remains at the current level ( which is 1. 29 ), then “ the last baby will be born in about eight hundred years ”. 1 south korea, taiwan, china and australia will follow a similar process in the absence of immigration, although the speed of their ageing process is divergent ( figure 1 ). 2. effects on the macroeconomy to start with the issue of the decrease in the working - age population, it is clear that the economic growth rate will fall due to the decline in labor input. krugman ( 1998 ) argued that the expected negative growth rate due to ageing is the basic cause of deflation in japan, given the condition that the real interest rate cannot fall below zero under the constraint of a zero interest rate combined with persistent deflation. nevertheless, the

the life cycle as well as the assets of firms. in japan, the major portion of household savings is held by the elderly, that is, people over 60 years old. it is well known that labor supply flexibility creates a kind of insurance against the risk of financial investment. young people have greater labor supply flexibility and thus may take larger financial investment risks than the elderly. 7 the preference for safe assets among japanese households can be partly explained by the labor supply inflexibility of the elderly and the lower labor mobility. more specifically, the lifetime employment system combined with the seniority wage system has implied that workers invest in equity of the employed company by the difference between the received wage and the marginal productivity of labor when they are young. in old age, the workers receive a higher wage than marginal productivity and the severance payment at retirement. therefore, there is much less need for young households to hold risky financial assets such as shares and investment trusts, because the return on human capital over the life cycle is associated positively with the return on risky financial assets. the long - term profit - sharing aspect of wage payment has been reinforced by employees ’ deposits at their companies during the high - growth era and employees ’ stockholding in more recent decades. other factors bringing about a smaller share of risky financial assets held in the japanese household portfolio balance may be the borrowing constraint and the relatively high share of risky real asset holding ( housing and real estate ). it may be noted that, in japan, there is no system such as the “ home equity loan ” in the united states that promotes borrowing, consumption and equity investment when housing prices rise. the demographic changes are working to transform the traditional employment system into a new one. the structural changes in the japanese labor market have tended to cause a shift from a seniority wage system to a performance - based system. the lifetime employment system has been eroded significantly by the increasing share of part - time and temporary workers. the delinking between the return on human capital and equity investment may enhance the tendency for the household sector to hold more risky financial assets such as shares and investment trusts in the future. it is accompanied by changes in the incentive structure for young workers ; namely, an increasing number of young non - regular part - time employees ( known as “ freeters ” ) totaling nearly 4. 2 million and 0. 52 million discouraged young people who are not in education, employment or training ( known as “ neet ” ). for these young people, it is difficult