Demography and Exchange Rate Movements : Evidence from Sweden

Sammanfattning: This thesis analyzes how demographic changes influence the real effective exchange rate in Sweden. The study develops and tests recent models used to examine the link between the age structure of the population and the real effective exchange rate. One paper has explored this connection in Sweden; it found a relationship between changes in the Swedish demographic structure and the Swedish real effective exchange rate. The study at hand, however, instead argues that relative demographic change, in this case, the change in the Swedish age structure relative to that of its trading partners, is a superior explanatory factor when determining exchange rate movements during the sample period, the first quarter (Q1) of 1961 to 2016Q2. In order to investigate this, an ordinary least squares (OLS) model and a fully modified least squares (FMOLS) model are estimated and compared to a model using only the domestic age structure and to a random walk model (RW). The results show that the OLS and FMOLS models outperform the model using the domestic age structure for all forecast horizons, and the RW for all except at the shortest one. In addition, the conclusion in this thesis changes when relative demographic changes, instead of domestic changes, are used as explanatory factors in the model. This show that the prime aged population (i.e., people aged 25-49 years) has a depreciating effect on a real weighted index of the Swedish krona while the other age groups have the opposite effect. Lastly, forecasts were generated for the period 2016Q3 to 2032Q2 in order to explore how future demographic changes are expected to affect the Swedish real effective exchange rate. The results show that the Swedish krona is projected to undergo real depreciations until 2032Q2.