A Study on How an Aging Population Affects the Effectiveness of Fiscal Policy Using an ARDL Model

Purpose - This paper examines the impact of an aging population on fiscal policy efficiency. Two significant issues arise from Korea’s aging population: old age poverty and the sustainability of government debts. As Korea’s demographic trajectory is similar to that of Japan, it is vital to study fiscal soundness and efficiency from various points of view. Design/Methodology/Approach - The Autoregressive Distributed Lags (ARDL) - EC model was adopted. ARDL shows statistically robust results when the data are a mixture of stationary at the level or the first difference. The data was downloaded from 1994 to 2019 of five OECD countries; Canada, Japan, Spain, Sweden, and Korea. The country selection followed the regime classification of OECD (2012) based on the labor market structure and redistribution effect after tax. Findings - First, the dependency ratio negatively affects the efficiency of fiscal policy. The marginal propensity was suppressed due to the consumption variance in old age cohorts as the dependency ratio increases. Economic agents react to save for future uncertainty when government spending is funded by issuing debt. Second, the long-term elasticities differed among countries, with Korea having the highest at 0.56, followed by Canada at 0.55, Spain at 0.39, and Japan at 0.36. Research Implications - Efficiency of fiscal policy is dependent upon the reactions of economic agents. The priority of the government should focus on managing the future expectations of economic agents by implementing structural reforms in the labor market and pension system.