Aging Economies May Benefit Less from Fiscal Stimulus – IMF

Fiscal policy is not effective in boosting growth in economies with older populations compared to economies with younger populations, International Monetary Fund (IMF) reports.

A research conducted by IMF has proven that fiscal stimulus in economies with a younger population has a significantly positive effect on growth, but the effect is much weaker in aging economies.

According to reports, the importance of fiscal policy has been increasing, with monetary policy constrained by near-zero interest rates even before the present crisis. The advent of the novel coronavirus has made the situation worse by causing policymakers around the world to undertake fiscal stimulus—a combination of spending increases and tax reductions—to support their economies. 

The IMF report which studied 17 Organization for Economic Cooperation and Development (OECD) countries from 1985 to 2017 categorically states that age also matters when considering fiscal stimulus.

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The survey split the sample into two groups by looking at the ratio of old people among population. 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.

According to the findings, an aging economy behaves this way because its labor force is not growing, while its public debt tends to be high, therefore, fiscal stimulus has weaker effects on private consumption and investment.

“This is because the working age population is more likely than retirees to benefit from fiscal stimulus through effects such as increased corporate hiring. Furthermore, many pensioners are on fixed incomes whose consumption remains steady or even declines over time.”

It added that an aging population could reduce potential growth as labour and productivity is reduced which in effect reduces the rate of private investment.

“The older the economy and the higher its debt, the less impact fiscal stimulus has on growth.”

Notwithstanding, these findings complement existing observations that countries with aging populations have relatively low growth and higher public debt. However, IMF’s findings indicate that old-age dependency ratios 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.”

Meanwhile, the report suggested a few things policymakers in aging economies could consider to support aggregate demand with their weaker growth impact of fiscal stimulus.

“The paper draws the following implications for policymakers to consider: 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.”

It added that such countries should “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.”