Final answer:
The aging population, largely attributed to the baby boom generation reaching retirement age, is leading to higher government service demands and subsequent increased government deficits.
This trend impacts domestic investment and can cause economic strain as the government navigates funding for social programs, managing debt, and maintaining fiscal confidence.
Step-by-step explanation:
Demographics play a significant role in shaping economic policy and fiscal stability. As the population ages, a phenomenon caused by the 'baby boom' period following World War II, there arises an increased demand for government services such as Social Security and Medicare.
Starting in 2010, baby boomers began reaching the age of 65, leading to a substantial rise in the proportion of Americans over that age. Consequently, the current level of payroll taxes is not sufficient to cover the projected expenses of these programs, resulting in forecasts of large budget deficits.
The balance between the government's borrowing to fund these deficits and the need to invest resources into domestic investment is delicate. High government borrowing and interest payments can divert funds away from critical investments in human and physical capital, which are necessary for economic growth.
In the future, budget choices may include increasing revenue or decreasing benefits to manage these deficits.
Rising interest rates and the proportion of debt to GDP can generate uncertainty in financial markets and put pressure on governments to employ strategies, including inflationary measures to devalue real debt, which can lead to decreased real wealth and damaged confidence in the government's fiscal management.