Declined effectiveness of fiscal and monetary policies faced with aging population in Japan

- Studies how population aging affects the effectiveness of fiscal and monetary policies.
- DSGE model with heterogeneous households is developed.
- Show population aging weakens the effectiveness of fiscal and monetary policies.

This paper studies how population aging affects economic performance and the effectiveness of fiscal and monetary policies. We develop a New Keynesian dynamic stochastic general equilibrium model with heterogeneous households: workers and retirees. We demonstrate that an increase in the proportion of working population increases aggregate output, consumption, and investment by increasing total labor supply in the long run. It also increases wages and reduces the social security burden of the government. This paper also finds that the effectiveness of fiscal and monetary policies is weakened when the proportion of retirees becomes larger.