Aging, Healthcare System, and Interest Rates
By Reona Hagiwara
Over the past few decades, the Japanese economy has experienced the widening gap between returns on liquid bonds and illiquid capital (i.e., the liquidity premium) due to a secular decline in the real interest rate and a slight increase in the capital return. This paper explores the role of the health or medical expenditure risk in the increase in the premium, using a general equilibrium overlapping generations model with heterogeneous agents that differ in health status and medical costs. They can hold both bonds and capital, but their capital holdings involve adjustment costs. I find that both of structural changes in demographics and medical systems could have caused the past changes in the bond return, capital return, and thus, liquidity premium. While the aging population has pushed down both asset returns, the rise in medical costs has led to higher capital return and lower bond return by shifting the asset portfolio of older households from illiquid to liquid. The results suggest that these structural changes going forward will continue to contribute to a further increase in the premium in the future, even after accounting for the larger supply of government bonds.
Source @SSRN
