Ageing, Fiscal Sustainability, and the Design and Political Economy of Fiscal Rules

Advanced economies face growing and unprecedented demographic challenges which threaten fiscal sustainability and economic growth. This paper derives welfare-consistent fiscal rules that condition debt, taxes, and discretionary spending on demographic structure, showing how demographic contingency can smooth fiscal distortions while preserving political feasibility. Using an extended overlapping generations model with distortionary taxation, the analysis demonstrates that ageing substantially reduces GDP per capita, lowers productivity, and increases government debt as tax revenues fall while age-related expenditures rise. The welfare-theoretic framework yields three optimal fiscal rules: demographically-contingent debt targets, tax smoothing with demographic adjustment, and expenditure restraint on discretionary spending while accommodating age-related costs. The paper also addresses political economy constraints, which fundamentally affect responses. Time inconsistency problems intensify with ageing as median voters become older, generating systematic bias toward excessive debt accumulation. Institutional quality appears decisive as strengthening fiscal institutions substantially reduces political economy costs and supranational frameworks outperform national rules through stronger commitment mechanisms. Timing of action is also critical as welfare costs increase with delay. The paper also presents an integrated policy framework combining age-responsive fiscal rules, pension and healthcare reforms, productivity-enhancing structural policies, and institutional strengthening can substantially mitigate adverse fiscal impacts, though implementation depends critically on early action during anticipatory phases when comprehensive reforms can be sustained and before political constraints become binding.