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[2022-12] The Impact of Demographic Changes on the Growth Effect of Fiscal Expenditures

Group : Macro Economy
Research Department (02-759-4150) 2023.01.20 18594

Since the COVID-19 outbreak, as part of efforts to prevent a rapid economic contraction, major countries executed large-scale fiscal expenditures, highlighting the importance of fiscal policies in response to a crisis. This also clearly showed that we need to stablize the economy by enhancing the growth effect of fiscal spending, while still focusing on securing fiscal capacity to deal with potential crises. A recent overseas study found that demographic changes, such as an aging population, not only negatively affect fiscal soundness, but also weaken the effect of fiscal expenditure on GDP. This paper looks at whether Korea’s demographic change weakens the growth effect of fiscal spending, and presents policy implications.

 

First of all, we did an empirical analysis using Korean data based on the methodology of existing studies. The results show that every 1%p increase in the share of old-age population will lead to a 5.9% drop in the impact on economic growth from government spending. These results are overall consistent with those from previous studies conducted in the U.S. and in OECD countries (including Korea).

 

Next, previous studies noted that an aging population can act as one of the major transmission channels that weaken the growth effect of fiscal expenditure. This happens through a reduction in the labor supply, the quality of employment, and propensity to consume. This led us to develop a DSGE model that reflects the situation in Korea, and to see if an ageing population weakens the growth effect of fiscal expenditure through the aforementioned channels. It turns out that the cumulative fiscal multiplier fell from 0.78 to 0.73 two years after the proportion of elderly households with a low labor supply, low employment quality, or a weakened consumption tendency increased by 1%p. This means that in Korea, too, an aging population can weaken the growth effect of fiscal spending through the channels mentioned above.

 

The implications drawn from the findings of this paper are as follows. First, considering that an aging population is likely to require a heavier fiscal burden due to rising welfare expenditures and the weakened growth effect of fiscal expenditure, it is noteworthy that Korea will need to focus its efforts on securing fiscal capacity with the long-term perspective in mind. Second, as any economic downturn with an aging population will require a larger scale of fiscal expenditure than before, it is necessary to be prepared by further strenghtening fiscal soundness preemptively when the economy is in a stable condition. 

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