Working Paper

Aging and deflation from a fiscal perspective

Abstract: Negative correlations between inflation and demographic aging were observed across developed nations recently. To understand the phenomenon from a politico-economic perspective, we embed the fiscal theory of the price level into an overlapping-generations model. In the model, successive short-lived governments choose income tax rates and bond issues considering the political influence of existing generations and the policy response of future governments. The model sheds new light on the traditional debate about the burden of national debt. Because of price adjustments, the accumulation of government debt does not become a burden on future generations. Our analysis reveals that the effects of aging depend on its causes. Aging is deflationary when caused by an increase in longevity but inflationary when caused by a decline in birth rate. Numerical simulation shows that aging over the past 40 years in Japan generated deflation of about 0.6 percentage points annually.

JEL Classification: D72; E30; E62; E63; H60;

https://doi.org/10.24149/gwp218

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2014-11-01

Number: 218