Macroeconomic Effects of Medicare

Juan Carlos Conesa

Daniela Costa

Parisa Kamali

Timothy J. Kehoe, Consultant

Vegard Nygard

Gajendran Raveendranathan

Akshar Saxena

April 2017 | Federal Reserve Bank of Minneapolis Staff Report 548

This paper develops an overlapping generations model to study the macroeconomic effects of an unexpected elimination of Medicare. We find that a large share of the elderly respond by substituting Medicaid for Medicare. Consequently, the government saves only 46 cents for every dollar cut in Medicare spending. We argue that a comparison of steady states is insufficient to evaluate the welfare effects of the reform. In particular, we find lower ex-ante welfare gains from eliminating Medicare when we account for the costs of transition. Lastly, we find that a majority of the current population benfits from the reform but that aggregate welfare, measured as the dollar value of the sum of wealth equivalent variations, is higher with Medicare.