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Global aging pressures: impact of fiscal adjustment, policy cooperation, and structural reforms

Author: DENNIS BOTMAN AND MANMOHAN S. KUMAR
Published in PFM, Vol. 8 No. 3

This paper undertakes a rigorous analysis of the effects of policies to respond to the looming demographic pressures in Europe and elsewhere. We examine the impact of fiscal adjustment by itself, and when pursued in combination with tax, labor and product market reforms, using the IMF’s Global Fiscal Model (GFM), calibrated to the German economy, the euro area, and the United States. We also explore the international spillover effects of demographic pressures and associated fiscal adjustment, and the benefits of cooperative action. In addition, we examine the extent to which structural reforms (including tax reform) to boost productivity growth, labor participation, and product market competition could ameliorate the adverse short-term effects of adjustment. The results suggest (i) substantial spill-over effects of aging on debt sustainability through international financial channels; (ii) the preferred adjustment package is broad-based relying on both revenue and expenditure measures while avoiding increases in direct taxes; and (iii) there are substantial benefits from fiscal cooperation. Nonetheless, even a cooperative response has initial contractionary effects, and we show that these effects can be offset by combining fiscal adjustment with expeditious implementation of structural reforms in product and labor markets, as envisaged in the Lisbon Agenda. Moreover, the benefits accrue early and to all income-groups if the reforms are implemented as part of a package.

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