Demographics are likely to have a large negative influence on global housing prices, and by extension, financial asset prices, over the next 40 years, challenging both household and government fiscal positions, new research suggests.

A new working paper published Wednesday by the Monetary and Economic Department of the Bank for International Settlements looks at how aging affects asset prices. It examines real house price data from 22 advanced economies (including Canada) between 1970 and 2009, and finds that demographic factors affect real house prices significantly. As a result, the paper predicts that the expected aging of populations in advanced economies “will lower real house prices substantially” over the next 40 years.

“Though the results do not imply absolute real price declines, they suggest that in the next forty years house prices in advanced economies will face a more difficult environment than in the past forty years,” it says. And, it cautions that real house prices are affected by many other factors which could well compensate for the demographic headwinds.

Moreover, the paper suggests that these results can be used to think about the wider implications for other asset prices, such as financial assets. “However, the mapping between real house and financial assets is not linear,” it notes, adding, “the impact of aging on financial assets is similar to housing, but it might arise earlier, it could be somewhat weaker, and it is affected by global aging patterns.”

Combining global aging forecasts and the paper’s findings, it concludes that “financial assets prices would face around a full percentage point per annum demographic headwinds over the next forty years”; adding that this estimate is subject to both upside and downside risks.

“In a historic context, this asset price impact would be large, but would not imply long term real asset price declines, not to mention asset meltdowns,” it concludes. “The United States stock market has averaged an annual real return of 6.8 percent between 1802 and 2006. Shaving off around one percentage point from this return would be substantial, but does not seem to have catastrophic implications.”

Nevertheless, it points out that these results have some significant implications for both governments and households. “These asset price headwinds suggest that private and public pension systems are very similarly challenged by aging,” it adds, as, “Public pay-as-you-go systems will not find enough net contributors, while private pension funds will not find enough buyers for their accumulated assets. This implies that privatizing pension provision might not be the panacea for aging related challenges.”

And, it suggests that these demographics-driven asset price headwinds could also be relevant to financial stability. “Advanced economies, households, private institutions and the public, have accumulated substantial debt in the past few years. The results of the paper suggest that the assets financed by this debt could come under long run pressure. In particular, long run asset price headwinds could complicate the unwinding of leveraged financial positions. As for the future, this possibility suggests continued vigilance against the further build up of such positions,” it says.

The paper suggests that government debt sustainability will also come under increasing pressure. Not only does aging increase government expenditures, especially pension and health care spending, and slow economic growth as labour supply growth slows, but, it points out, “Lower asset prices imply that long run interest rates will face upward pressure in the future. These higher long term interest rates would make debt sustainability even more challenging.”

IE