Fiscal Policy Effects in a Heterogeneous-Agent Overlapping-Generations Economy With an Aging Population

Among the models that the Congressional Budget Office uses to analyze the economic effects of changes in federal fiscal policy is a life-cycle growth model with overlapping generations of heterogeneous households. In this paper, we extend a similar dynamic model by incorporating a population that ages in a manner consistent with projections for the United States. Under that extension, gross domestic product per capita is projected to be about 7 percent lower in 2040, and more than 11 percent lower in the long run, if the government cuts transfer rates and increases income taxes to finance the budgetary cost of an aging population, compared to results from a similar model without an aging population. In addition, the paper shows that considering an aging population is important in analyzing long-term policy changes that involve intergenerational transfers.