Introduction

During the final decades of the twentieth century, most European countries accumulated large, and in peacetime unprecedented, public debts. Interest payments on the debts now constitute an important fiscal burden. Today these countries also face another challenge to the public budget. In the coming thirty to forty years, the share of people of working age is predicted to fall significantly. Considering this reduction in the relative size of the labour force, it may be wise to start adjusting public policy now. In particular, fiscal constraints may become less tight in the future if public debts are reduced today. This chapter explores what paths for the public debt and the budget surplus are optimal in the face of ageing populations.

Twelve European countries are included in the study. For all these countries, the optimal policy is to start reducing public debt immediately and continuously until some time between the years 2030 and 2045. The optimal average budget surplus varies between 1 and 4 per cent of output annually for these countries. The calculations show that for most countries the welfare loss of pursuing a balanced-budget policy instead of the optimal debt policy would be modest but not negligible.

The demographic change

Figures 14.1–14.3 show the historical and predicted demographic development in the countries considered. Figure 14.1 clearly displays that the share of workers in the population will fall during the coming thirty years.