Abstract: This paper investigates the effect of child dependency on the economy and external imbalances under an asymmetric demographic and productivity transition within a lifecycle model. It embeds dependent children within a two-country model with lifecycle features to examine child dependency’s effect on the economy and external imbalances. Specifically, the paper compares the effects of the same fertility and mortality shocks across models with and without children. Simulations show that child dependency changes both the steady-state and the transition dynamics under a demographic shock. The paper finds that while child dependency changes the direction of the impact of the fertility transition on external imbalances in the short run, it changes the magnitude of the effects in the long run. Furthermore, the model comparison shows that parameters must be chosen differently across models with and without child dependency to start from the same interest rate in the steady-state. Different calibration affects the magnitude of the transition dynamics of different models. These findings illustrate the importance of considering child dependency in studies that seek to explain the historical contribution of demographic changes to external imbalances, and suggest to approach studies that use models without child dependency for this purpose with caution.
Keywords: Global imbalances,Trade imbalances, Demographic transition, Life-cycle model