Long-Term Contingent Liabilities and Sovereign Risk: The Fiscal Impact of an Aging Population

On the back of declining fertility levels and increasing life expectancies, the aging of populations is indisputable. Since 1960, the median age in most countries has increased, and is projected to continue doing so. The same is true of other commonly used indicators such as the old age dependency ratio which measures the proportion of the population above 65 years of age compared to that of the working‐age population. Further, given that the decline in fertility levels is expected to be permanent, the trend of population aging is considered irreversible for the foreseeable future.

These trends are considered problematic in that an aging population requires increasingly larger outlays on healthcare and pension benefits. Other things equal, this may increase the size of government, necessitate larger budget deficits, and perhaps alter established patterns of taxation and growth. Lifecycle choices over consumption and savings will change. Effects of population aging on social structures such as family composition, living arrangements and migration will also indirectly impact private and public aging‐related expenses. Each of these factors affects a country’s debt‐service capacity.

The objective of this Capstone project is to build an analytical tool for Moody’s Sovereign Risk group to assess the impact of an aging population on public finances. In their final report, the team described a comprehensive framework for characterizing the aging process in various countries and its differential effects. The team narrowed the range of the analysis by focusing on the “end results” of the aging process: demographic change, increases in public expenditures for the elderly, and political willingness and budgetary flexibility to contain rising costs. The team developed a framework that assesses the vulnerability of a country’s finances to population aging based on these three factors.