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A paper released yesterday by the Monetary Authority of Singapore (MAS) has found real evidence that a decline in a country's fertility rate of one child per woman leads to a depreciation of about 0.15 per cent in the real effective exchange rate of the country's currency.

This effect is 'of plausible economic size, being neither trivial nor incredibly large', observed the authors of the paper, Andrew K Rose and Saktiandi Supaat.

Their paper comes at a time when governments in developed countries, including Singapore, are worrying about how to boost declining birth rates. United Nations data show that the average world fertility rate has fallen dramatically - declining some 48 per cent from 3.92 in 1970-85 to 2.65 25 years later. This still means a rising world population, but in Singapore, the fertility rate is at an even lower 1.26 and well below the 2.1 replacement level.

This new study examines the consequences of such demographic changes on international finance, particularly on the real exchange rate for national currencies.

It was based on data for 87 countries (including Singapore and other developed nations as well as developing countries) between 1975 and 2005. The authors described this as a 'sample of great demographic change and cross-country heterogeneity'. They cut the sample up in a number of different ways, such as by dropping observations for developing countries or those for high-income countries, to test whether the linkage between fertility and the real exchange rate held.

'None of these checks shake our confidence in the basic result. The effect of the fertility rate on the log of the real effective exchange rate is always estimated to be positive, with a semi-elasticity of around 0.15,' the authors said in their paper.

They had also accounted for a number of other reasons why exchange rates adjust, including deviations from Purchasing Power Parity, the effects of trade liberalisation, government spending, net foreign assets, and so on. But they still found that one fewer child per woman on average is associated with a real effective depreciation of around 0.15 per cent. 'This result seems sensible and plausible; it is also quite robust,' they said.

The empirical evidence supports the intuitive theoretical linkage between the fertility rate and the real exchange rate. The Life-Cycle theory argues that raising children will lead to increased consumption and thus reduced savings, as children tend to consume more than they produce.

Therefore, if a country has fewer babies, savings are expected to increase. Investment may also drop if there is a decline in the future equilibrium capital stock resulting from a smaller populace. If savings rise and investment falls, the current account improves and a real depreciation of the exchange rate is required to deliver this current account response.

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