Aging Economies May Benefit Less from Fiscal Stimulus

IMF Blog, August 7, 2020

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Fiscal policy isn’t as effective in boosting growth in economies with older populations, compared to economies with younger populations.
The analysis covers 17 Organization for Economic Cooperation and Development countries from 1985 to 2017.
In the aging economies, the average old-age dependency ratio (defined as the ratio of people 65 and older to those between 15 and 64 years old) is 26.5 percent whereas in non-aging economies it is 18.9 percent.
The chart of the study shows fiscal stimulus in economies with a younger population has a significantly positive effect on growth, but the effect is much weaker in aging economies.

Labor force dynamics:
- Aging economies’ labor force isn’t growing, reducing the channels (for example, increased corporate hiring) through which fiscal stimulus boosts private consumption and investment.
Income composition:
- Many pensioners are on fixed incomes whose consumption remains steady or even declines over time.
Public debt and potential growth:
- Aging economies tend to have high public debt, which weakens the transmission of fiscal stimulus.
- Population aging could reduce potential growth (by lowering labor input and productivity), with which fiscal stimulus may induce less private investment.
Interaction:
- The “older” the economy and the higher its debt, the less impact fiscal stimulus has on growth.

Even before the COVID-19 pandemic, the importance of fiscal policy was increasing because monetary policy was constrained by near-zero interest rates.
Old-age dependency ratios have been rising for several decades and are projected to increase further.
Within the next 30 years, more than 20 countries across the world would exceed the old-age dependency ratio of 50 percent—an unprecedented level in global history—with some even reaching 70 percent.

A larger fiscal stimulus may be required to support aggregate demand during recessions.
Given the lower output effects of fiscal stimulus, other economic policies (including structural reforms) would need to play a more important role in supporting domestic demand.
- Policy measures to enhance labor supply (for example, through stronger female labor force participation or labor market needs-based immigration) would help increase the output effects in aging societies.
Secure sufficiently large fiscal space (room to raise spending or lower taxes more than previously planned, without endangering debt sustainability or access to capital markets) during booms, in order to prepare for a larger fiscal stimulus during recessions, without creating concerns for fiscal sustainability.

Jiro Honda and Hiroaki Miyamoto, August 7, 2020.