1  The scale of the phenomenon is truly unprecedented, yet the causes are well known. There are two main and quite clear reasons behind this demographic transformation. First, the fertility rate has dropped substantially since the second half of the 20th century. Specifically, the number of live births per woman has halved, from 5 in 1950 to 2.5 in 2020. And second, life expectancy has increased dramatically, in parallel with extensive improvements in health and nutrition. While world life expectancy at birth stood at only 47 years in 1950, it exceeds 72 years today. In other words, since 1950 life expectancy has increased by 3.5 years for every decade. The fall in fertility and the rise in longevity also mean that, in the coming decades, the working age population will grow significantly more slowly than total population. Not only  2  that: it is worth noting that in some geographical areas this divergence might become dramatic. For instance, the United Nations (UN) estimates that in Europe the number of deaths has outnumbered that of births since the mid-1990s. As a result, the UN projects that the workforce in Europe will shrink by close to 80 million people from now to 2050. This is equivalent to saying that Europe will lose 1.6 out of 10 workers over the next 30 years. Note also that this projection already incorporates a positive net inflow of migrants that would offset, to a degree, the labour supply shortage.
In such a world, by adjusting the level of the federal funds rate, the FOMC could be fully confident that it could generate the appropriate financial conditions necessary to support achievement of full employment and price stability. In fact, the response of financial conditions to changes in short-term interest rates is not rigid and predictable. Instead, as we shall see shortly, the linkage between the federal funds rate and financial conditions changes over time, as it is influenced by a whole host of other factors. Recent evidence suggests that even the relation between short-term and long-term rates has shifted substantially over the past 15 years.4 Moreover, at times, we have observed cases in which financial conditions did not move in the same direction as the monetary policy stance. Let me highlight two recent divergences which indicate that we need to keep a separate eye on the evolution of financial conditions. The first occurred in the mid-2000s. In June 2004, the FOMC decided to begin raising the federal funds rate target in order to remove policy accommodation. It raised the target in 25-basis-point increments at 17 consecutive meetings, pushing the rate up from a starting point of 1.0 percent to a peak of 5.25 percent. Despite this tightening of monetary policy over two years, financial conditions failed to tighten in a similar manner. This can be seen by looking at the behavior of well-known measures of financial conditions during this period (Exhibit 1).