Age-dependent Risk Aversion: Re-evaluating Fiscal Policy Impacts of Population Ageing

Abstract

This study revisits optimal fiscal policies in response to population ageing by introducing an age-dependent increasing risk aversion assumption into an OLG model with risk-sensitive preferences. Under this specification, the policy evaluation factors in the welfare cost of policy-induced uncertainties and suggests that, based on future generations’ welfare, financing population ageing by either reducing social security benefits or extending the retirement age may not be as strongly preferred over raising the payroll tax rate as prior studies have suggested. Varying risk aversion also emphasizes the role of precautionary savings that causes individuals to respond slightly differently to changes in demographic structures and price variables. This, in turn, influences the redistribution of life-cycle variables and transition dynamics of aggregate variables.