Abstract：As substantial demographic changes unfold at a globe level,the world population is getting older .Theoretically all European countries should have tax financed education,health care and public pension systems,because there is a strong age component with respect to when the representative benefits from and contributes to public finances .However,the government may run deficits to smooth adjustments across time and generations given a policy package such as high welfare standards . Therefore,ageing and high public welfare expenditure are important factors of debt sustainability in Greece,Italy and other European countries .This paper proposes that bond issue is gradually turning into the primary means for governments to plug their fiscal shortfalls since rigid fiscal unproductive expenditure could not generate tax revenue .Besides,the government financial situation gets even worse because of welfare system mismatch which leads to a full-blown debt crisis eventually . Based on the three-period OLG model,we discuss the net contributions of representatives of different stages in the public sector,and integrate demography and welfare expenditure into the analysis framework of sovereign debt according to the fiscal gap model .The proposition we put forward is that ageing and the rise of social security expenditure would lead to the increase of government debt ratio .In this paper,empirical research was conducted in 28 European countries from 2003 to 2012 .We constructed variables,including the proportion of the population aged 65 or above,old age dependency ratio,life expectancy to capture the demographic transition;relative median income ratio,aggregate replacement ratio,expenditure on pensions,social protection,health care,and education to capture welfare system arrangement;and adopted the inflation rate,average yields of national debt,birth rate,economic growth rate,fiscal deficits,tax revenue as control variables .Considering heteroscedasticity of panel data,we made use of the fixed effects model with clustering robust standard deviation,and applied first-lagged variables to control the possible endogeneity . The empirical results show that :(1) Consistent with the theory,aggregate replacement ratio,expenditure on social protection,and old age dependency ratio have positive influence on scale of debt .(2) Aggregate replacement ratio is less significant when debt ratio is higher than 60%,however it is very significant otherwise .This is because aggregate replacement rate maintains stable and does not change with the increase of debt ratio when debt ratio is high .In other words,governments don't have the ability to continuously improve welfare because of fiscal dilemma which leads to the stagnation of treatment for retirees after achieving a certain level .(3) At a high debt level,expenditure on social protection and old age dependency ratio have more significant marginal effect which coming from the expansion of the aging population .In short,the scale of debt will still grow geometrically under the present welfare system . This paper provides a new theoretical framework about sovereign debt from a demographic perspective,confirms the significant relationship among ageing,public welfare system and government debt in theory and practice,and indicates that controlling the speed and cost of population aging is an effective means of maintaining appropriate scale of sovereign debt .
