Macroeconomic Effects of Demographic Change in an OLG model for a Small Open Economy - The Case of Belgium.

In the absence of behavioural adjustments, demographic change may cut off about 0.4%- point on average from the annual per capita growth rate in the next 25 years. The behavioural responses of households and firms to declining fertility and rising life expectancy may significantly change this outcome, but the sign and the size of this change are unclear. In this paper we construct and parameterize a large-scale OLG model for a small open economy to quantify (the net effect of) these behavioural adjustments. Important endogenous variables in the model are hours worked and (un)employment, investment in human and physical capital, per capita growth and inequality. Individuals differ not only by age, but also by innate ability. We calibrate the model to Belgium and find that it replicates key data since about 1960 remarkably well. Simulating the model, we observe significant (positive) behavioural adjustments by households and firms, but these do not reverse the negative arithmetical effect of projected future demographic change on per capita growth. Many of the adjustments have already taken place in previous decades. Furthermore, ongoing adjustments do not affect future domestic output due to capital outflow in a small open economy. To counter (very) poor per capita growth in the next two decades, policy changes will be necessary.

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