Sustainable Fiscal Strategies under Changing Demographics

This paper develops an overlapping generations model to evaluate, first, the steady state growth-maximizing level of public debt around which an economy needs to stabilise; second, how the optimal level of public debt varies as a function of key population parameters; third, how fiscal rules designed to stabilise the economy around that debt level need to vary with the population parameters; and, fourth, how well the model performs as a reasonable and plausible representation of the advanced economies that face fiscal strain and deteriorating demographics. The main conclusion is: despite diminished fiscal space and flexibility due to deteriorating population parameters, a relatively benign steady state is feasible and available under mild fiscal restraints. The bigger problem will be how to get there without financial or fiscal breakdowns along the way. We offer some political economy perspectives on how best to manage that risk.