Chapter II. A Leap Beyond Traditional Fiscal Indicators: Measuring Poland’s Intertemporal Net Worth and Deriving its Policy Implications1
1. Traditional fiscal indicators focused on the level of deficit and debt show that Poland’s fiscal position has worsened considerably. The decline in Polish economic activity due to the 2008-09 global economic crisis led to a fall in fiscal revenues—the so-called automatically stabilizing response of the fiscal accounts to the cycle—albeit this was less severe than elsewhere, given that Poland was the only country in Europe to have avoided a recession in 2009. In addition, discretionary measures adopted before the crisis that lowered personal income taxes and social security contribution rates came into effect just as the crisis hit: an ex-ante unanticipated yet ex-post well timed fiscal stimulus. As a result, the overall fiscal deficit increased to above 7 percent of GDP and gross public debt to about 50 percent of GDP in 2009, placing Poland around the EU27 average on both measures (Figure 1).
Figure 1.Poland: Traditional Fiscal Indicators in a Cross-Country Perspective, 2009
Source: IMF, World Economic Outlook.
2. More complex, forward-looking measures also imply a deterioration in Poland’s long-run fiscal position, though it remains relatively better compared to peers. Traditional indicators only capture the effects of past and current policies and events on countries’ current fiscal positions. But more comprehensive indicators of fiscal sustainability, including those developed by the European Commission, try to encompass both the initial fiscal position and a measure of future prospects under current policies, notably including the potential effects of population aging. These indicators measure the required upfront fiscal adjustment needed to either maintain debt at the Maastricht level after 2060 (the S1 indicator) or to satisfy the government’s intertemporal budget constraint over an infinite horizon (the S2 indicator).2 According to the EC’s latest Sustainability Report, Poland’s long-run fiscal position has deteriorated since 2006, with both measures showing the need for an upfront adjustment of some 3 percent of GDP to maintain sustainability in 2009, compared to no adjustment required three years ago. This is due to both a deterioration in Poland’s headline deficit and revisions to its estimated aging costs. Nevertheless, Poland continues to rank relatively favorably in a cross-country context, due to pension reforms adopted in the 1990s that substantially lowered its aging costs (Figure 2).
Figure 2.Poland: European Commission Long-Term Indicators
|Structural primary balance||Change in age-related expenditure||S1||S2|
|2008||2009||Total S1||IBP*||DR*||LTC*||Total S2||IBP*||LTC*|
3. Under existing national and international frameworks, fiscal assessments and policy-making decisions remain governed by traditional indicators. Given that these indicators are easy to measure and explain to the public, they constitute the basis of the European Union’s fiscal coordination mechanisms under the Stability and Growth Pact (SGP). Under the pact, countries whose deficits and debts have deteriorated recently—Poland included—are required to undertake a relatively larger fiscal effort to return their deficits to the 3 percent of GDP limit (as required under the Excessive Deficit Procedure) relative to countries with lower current deficits and gross debts—which are seen as having more “fiscal space.” Similarly, national policies generally target short-run indicators, such as the level of the deficit, structural deficit, or debt. In Poland, policies need to adjust when debt reaches 50 and 55 percent of GDP, and the Constitution establishes a 60-percent-of-GDP ceiling for national debt.
4. But the emphasis on short-run indicators can distort policies, especially at times of crisis. It has been documented that, in downturns, countries resort more frequently to short-run temporary solutions to lower their deficits. Sometimes, these measures include creative accounting and may even worsen their long-run fiscal positions.3 This could be exemplified by a recent trend seen in some Eastern European Countries (EECs) that are now partially back-tracking on their pension reforms by lowering or suspending the fiscal contributions to private pension systems in order to reduce their short-run deficits.4 These actions are the result of a perception of being effectively “punished” in an international context for having undertaken pension reforms, because such reforms temporarily increase short-run deficits and debt—in principal working against the SGP criteria, which apply uniformly to both reformers and non-reformers. Clearly, such tensions between the traditional and more forward-looking indicators are now surfacing within national policies in a number of countries, Poland included, with potentially negative long-run consequences for policy making.
5. Hence, an increasing awareness is slowly emerging to integrate more fully the essential long-run considerations into policy making, including through new analytical tools. The development and publication of the European Commission’s forward-looking indicators is a step in this direction.5 Nevertheless, these measures remain only indicative, are relatively little known by the general public and market participants, and do not carry the same political weight as traditional indicators, perhaps because of their complexity and difficulty to explain to voters. A new tool—the comprehensive public sector balance sheet—has been developed at the IMF, which mirrors the EC’s forward-looking indicators, but uses a framework that is somewhat more intuitive and could be easier to present to the public.6 As such, it may constitute a more practical framework for policy makers to integrate forward-looking considerations into their analyses and ultimate decisions.
6. The present paper applies the comprehensive balance sheet framework to the case of Poland to assess the public sector’s intertemporal net worth and provide policy recommendations. Poland lends itself naturally to this type of analysis, given that it is one of the countries where there is a tension between short-run and long-run indicators. Section II describes the analytical framework stressing its advantages, and outlines how it is constructed. Section III applies the tool to Poland and presents some measures of its intertemporal net worth. Section IV concludes with some policy recommendations.
B. What is the Public Sector’s Comprehensive Balance Sheet?
7. The public sector comprehensive balance sheet is a thermometer of fiscal health that measures the consequences of current policies on the fiscal accounts both at present and in the future. It is tool that can be thought of as the mirror image of the Aging-Working Group sustainability indicators. Rather than measuring the upfront primary balance effort required to satisfy a given intertemporal budget or explicit debt constraint (as the EC’s S1 and S2 indicators do), it provides a direct snapshot of a government’s net worth at a given point in time, under current policies. It does so by complementing the backward-looking traditional “accounting balance sheet” of a government with the effects of current fiscal policies on future assets and liabilities, thus becoming also forward looking. This measure can therefore gauge whether the government’s long-run intertemporal budget constraint is satisfied or not under current policies.7
8. It can provide early warning signs of fiscal (un)sustainability. In Poland’s case, traditional indicators such as short-run deficits and debt are larger than they would otherwise be, as a result of transition costs due to the 1990s pension reforms. The comprehensive public sector balance sheet would correctly capture both the short- and the long-run consequences of such reforms. However, if the resulting intertemporal net worth is negative—even after accounting for the long-run effects of pension reforms—this would signal the need to strengthen policies and bring total assets in line with total intertemporal liabilities, lest market forces eventually emerge to restore equilibrium. Since fiscal adjustment is often difficult and requires time for consultation with the public, there is value in having advanced information on prospective fiscal (in) consistency, which is why this tool can be seen as an early warning system.
9. It can also help to communicate policy needs in an intuitive way that is easier to grasp by the general public. The literature offers a variety of sophisticated models, such as overlapping-generation, computable dynamic general-equilibrium, and contingent-claims models, to analyze the long-run effects of fiscal policies and risks. However, these tend to have only a limited impact beyond the academic circles, perhaps because they are complex. Even the EC’s Aging-Working Group indicators reach a relatively limited audience partly due to the difficulty of relaying their message to the median voter. In contrast, the intertemporal net worth is a somewhat more straight-forward and intuitive concept, as more people understand the meaning of a balance sheet and of financial net worth. Consequently, it may be easier to use as a communication device with the public about the need to strengthen policies.
10. Constructing the comprehensive balance sheet requires two steps. First, it entails the building of a traditional backward-looking accounting balance, computed as the difference between a country’s fiscal assets and liabilities. Second, the traditional balance sheet needs to be augmented with the projected outcomes of policies in the future. The latter step requires a baseline macroeconomic and fiscal scenario asking the question: with current structural and fiscal policies, how many more assets and liabilities will the government likely generate in the future? The yearly projections of the future path of fiscal deficits net of interest payments, based on estimates from current policies, are then discounted and added up into a net present value measure. This measure is added to the current net worth to derive the intertemporal net worth. The next section exemplifies these steps for Poland.
C. Deriving Poland’s Intertemporal Net Worth
11. In a first step, Poland’s traditional public sector balance sheet is constructed, which shows a negative net worth of about 20 percent of GDP at end-2008. Financial liabilities, mainly comprised of public debt and other liabilities amounted to 54 percent of GDP at end-2008. At the same time, Poland’s financial assets, including shares, currency and deposits, and other assets, were estimated at about 34 percent of GDP at end-2008. Consequently, net financial worth—assets minus liabilities—equals about 20 percent of GDP (Table 1). A more comprehensive measure of current net worth would also include the public sector’s net capital stock—the sum of all buildings, highways, infrastructure, and land acquired by the state over the years. However, in the absence of data on this stock, only financial assets and liabilities are considered here, with financial net worth thus likely to underestimate Poland’s total net worth.
|Currency and deposits||3.3||3.9||4.8||4.8||6.3||6.3|
|Securities other than shares||0.2||0.2||0.2||0.1||0.0||0.0|
|Shares and other equity||16.4||17.0||18.3||19.9||20.7||20.1|
|Other financial assets||11.8||11.8||7.0||7.2||6.9||6.5|
|Currency and deposits||0.0||0.0||0.0||0.0||0.0||0.0|
|Securities other than shares||32.5||35.3||40.2||42.0||40.0||42.1|
|Traditional Financial Net Worth||-22.7||-20.8||-23.5||-22.4||-17.0||-20.3|
12. In a second step, Poland’s long-term fiscal outlook is developed based on a set of long-run macroeconomic projections. Medium-term GDP, labor market and fiscal projections correspond to the latest IMF outlook for 2009-15 (Tables 2 and 3).8 Long-run GDP and labor market projections converge to the EC’s assumptions, which take into account Poland-specific demographic projections, as presented in the 2009 Sustainability Report. The GDP deflator growth is assumed to converge to the ECB’s target of 2 percent in the long run, and the real interest rate is projected to stabilize at 100 basis points above real growth in the long run (Figure 3).9 Medium-term fiscal projections assume that the consolidation package announced at end-January 2010 will be implemented. All non-age, non-interest related fiscal revenues and expenditures, as well as financial assets and other financial liabilities except for public debt are assumed to remain constant in percent of GDP from 2015 onward. Net aging-related expenditures are taken from the EC’s Sustainability Report, which estimates them at -1.2 percent of GDP for 2010-60, making Poland the only EU27 country with negative aging costs.10 This suggests that the 1990 pension reform is expected to improve the long-run fiscal outlook, though not enough to prevent a build-up of public debt over time (Figure 4).
|Activity and prices|
|GDP (change in percent)||5.0||1.7||2.7||3.2||3.9||4.0||4.0||4.0|
|Domestic demand growth||5.5||-0.9||3.0||3.2||3.8||4.1||4.0||4.1|
|Private consumption growth||5.9||2.3||1.5||2.5||3.5||3.4||3.3||3.3|
|Public consumption growth||7.5||1.2||2.0||2.0||2.0||2.0||2.0||2.0|
|Domestic fixed investment growth||8.2||-0.3||4.5||6.0||6.0||7.5||7.5||7.5|
|Nominal GDP (zloty millions)||1,273||1,342||1,402||1,481||1,573||1,676||1,786||1,904|
|CPI inflation (average change in percent)||4.2||3.5||2.3||2.4||2.5||2.5||2.5||2.5|
|CPI inflation (end of period change in percent)||3.3||3.5||2.3||2.5||2.5||2.5||2.5||2.5|
|Gross domestic saving (ratio to GDP) 1/||18.6||18.5||18.7||19.0||19.3||20.2||21.1||22.1|
|Gross domestic investment (ratio to GDP)||23.7||20.2||21.5||22.1||22.6||23.4||24.2||25.0|
|General government revenue||39.6||37.4||39.4||39.7||40.2||40.4||40.5||40.6|
|Other current revenue||5.0||5.0||5.0||5.0||5.0||4.9||4.9||4.8|
|General government expenditure||43.3||44.6||46.8||46.6||45.9||45.4||44.9||44.4|
|Goods and services||6.2||5.9||6.4||6.4||6.3||6.2||6.1||6.1|
|Compensation of employees||10.0||10.2||10.0||10.0||9.7||9.5||9.2||8.9|
|Other current expenditure||2.6||2.5||2.5||2.4||2.4||2.3||2.2||2.2|
|Capital transfers and investment||5.4||5.7||7.4||7.5||7.6||7.9||7.9||7.8|
|General government balance||-3.7||-7.2||-7.5||-6.9||-5.8||-5.0||-4.4||-3.8|
|Structural primary balance||-2.1||-4.5||-4.5||-4.1||-2.9||-2.0||-1.3||-0.7|
|Public debt||47.2||51.0||55.0||58.3||60.5||61.6||62.3||62.2|Figure 3.Poland: Long-Run Macroeconomic Projections, 2000-60
Sources: European Commission; and IMF staff estimates.
Figure 4.Poland: Long-Run Fiscal Projections, 2000-60
Sources: European Commission; and IMF staff estimates.
13. Finally, the comprehensive balance sheet is constructed combining steps one and two above. This is done by discounting the stream of future primary balances using the nominal interest rate on debt. Two measures are constructed: one that discounts primary balances over a set horizon—50 years—and a second one that assumes an infinite horizon. The two net present values are then added to the current net worth, obtaining both an infinite and a finite-horizon measure of long-run net worth. One the one hand, the infinite-horizon measure is more comprehensive and theoretically appealing, as it considers the effects of current policies in the context of the government’s full intertemporal budget constraint. Nevertheless, it may be harder to grasp and could prove weaker from a policy point of view, as, theoretically, such constraints could be satisfied by very high levels of short-term debt and deficits, as long as there is reason to believe that sufficiently large primary surpluses will be achieved afterwards. On the other hand, the finite-horizon measure, although ignoring very long-term effects of current policies, can prove more practical, as it still allows a meaningful long-run analysis, while remaining within the sight of current taxpayers and policy makers.
14. For Poland, measures of intertemporal net worth are negative at about 74 and 145 percent of GDP and only slowly falling over time. Poland’s net worth has been calculated for several successive years, to gauge whether current policies imply a relatively constant, worsening, or improving net worth position. Given that primary balances are assumed to stabilize after 2015, given marginal aging costs going forward, their net present value gradually falls, broadly compensating for the expected yearly increase in public debt over the medium term. As a result, intertemporal net worth falls slowly during 2009-15 from 74 to 71 percent of GDP according to the finite-horizon calculation, and from 144 to 140 percent of GDP under the infinite-horizon measure (Table 4). These findings imply that, while current policies (including the recently announced fiscal consolidation package) are not sufficient to satisfy Poland’s intertemporal budget constraint, they are not worsening the long-run fiscal position.
|Current Financial Net Worth||-22.6||-26.6||-29.9||-32.1||-33.2||-33.8|
|NPV of primary balances (50 years)||-51.0||-46.7||-42.8||-40.2||-38.5|
|NPV of primary balances (infinite)||-122.5||-117.5||-112.9||-109.6||-107.2|
|Intertemporal Net Worth (50 years)||-73.6||-73.3||-72.7||-72.3||-71.7||-71.2|
|Intertemporal Net Worth (Infinite)||-144.4||-144.5||-143.2||-142.1||-140.8||-139.7|
15. Moreover, Poland’s intertemporal net worth is relatively limited compared with other European countries. Only a few European countries show a sustainable long-run fiscal position as a result of successfully containing the short-run fiscal deterioration due to the crisis in 2009-10 and of pension reforms that contained aging costs. At the other extreme, countries whose short-run fiscal positions deteriorated significantly, some of which also expect very large aging costs in the long run, have net worth in excess of negative 300 percent of GDP under the finite horizon measure and over 1,000 percent of GDP under the infinite horizon measure, suggesting a need for major fiscal consolidation. The EU-27 average is close to 200 percent of GDP under the first measure, and close to 700 percent of GDP under the second measure.11 Poland ranks well below the average on both these long-term measures, compared to around average on the basis of traditional fiscal indicators (Figure 5). This is mainly because its declining long-run aging costs are expected to partly compensate for higher medium-term deficits and debt.
Figure 5.Poland: Intertemporal Net Worth in a Cross-Country Perspective
Sources: IMF, World Economic Outlook; and IMF staff estimates.
16. The results for Poland appear fairly robust to changing assumptions, especially over a finite horizon. Varying assumptions does not appear to affect results for the finite-horizon measures of intertemporal net worth in a significant way. However, changing assumptions regarding the long-run interest rate differential relative to growth and aging costs seems to have an impact on the infinite-horizon measures. For example, an increase/reduction in the interest rate differential relative to growth leads to an improvement/worsening of the intertemporal net worth, as it lowers/raises the discount rate and hence the net present value of discounted primary balances. The effect is magnified at the infinite horizon, as the discount rate plays a larger role in the calculation of the net present value. Similarly, boosting/lowering long-run aging costs increases/shrinks the primary deficit and hence the negative value of intertemporal net worth. Again, the long-run value of the primary balance matters more in the calculation of net present value over an infinite-horizon relative to the finite horizon. Hence, the results should be interpreted with caution and updated when macroeconomic conditions change (Table 5).
|Finite horizon||Infinite horizon|
|Long-run real interest rate differential relative to growth|
|higer by 1/2 ppt||-4||-24|
|lower by 1/2 ppt||4||72|
|Long-run real growth rate (keeping the interest differential constant)|
|higer by 1/2 ppt||0||0|
|lower by 1/2 ppt.||0||0|
|Long-run aging costs|
|higer by 1/2 ppt||4||26|
|lower by 1/2 ppt.||-7||-33|
|Medium-run real growth rate|
|higher by 1/2 ppt.||-8||-10|
|lower by 1/2 ppt.||7||11|
D. Policy Implications and Final Remarks
17. Poland’s comprehensive balance sheet reveals an unsustainable long-run position. In contrast to traditional fiscal indicators that capture only the current state of public finances and reflect only a small portion of the government’s total obligations, the comprehensive balance sheet also takes into account the implications of current fiscal and structural policies for future debt. As such, this framework can be a handy tool to gauge the current fiscal position and set policy objectives in a manner that is consistent with long-run sustainability. Applying this tool to Poland shows that while its net debt represents only about 20 percent of GDP, comprehensive net worth is at around 74-145 percent of GDP. This difference shows that policies need to be strengthened to bring future liabilities in line with the government’s capacity to generate assets.
18. The current baseline analysis suggests that Poland’s current policies need to adjust by about 1.5 percent of GDP to ensure a balanced net worth position. A simple calculation can be made to see how much a 1 percent of GDP permanent improvement in the primary balance implemented in 2010 would yield in NPV terms. Compounding the 1 percent amount by a time-varying discount rate—taking into account GDP growth and the assumed interest rate—yields about 50 percent of GDP if it is done for 50 years, or 125 percent of GDP if it is done forever. Consequently, a minimum upfront adjustment of about 1.5 percent of GDP (in addition to the measures already announced by the authorities in early 2010) would be needed to bring intertemporal net worth to zero, thus satisfying the government’s intertemporal budget constraint.12 Alternatively, such a fiscal consolidation could be undertaken gradually, over a few years, although this would likely imply a somewhat larger overall adjustment. The current requirement under the EDP, which suggests an upfront consolidation of about 3 percent of GDP to attain the Maastricht deficit threshold of 3 percent of GDP by 2012 would be more than sufficient to also restore fiscal sustainability over the long run.
19. The fiscal adjustment should focus on spending reforms and be complemented by broad structural reforms. The comprehensive balance sheet does not provide a clear answer regarding the type of policies that would be desirable, except to say that they need to be permanent to have an effect on long-run net worth. Hence, this tool needs to be complemented with an analysis of country-specific circumstances to be able to deliver concrete policy recommendations. For Poland, given that ¾ of total spending is statutory, reforms, especially of social expenditures, are needed to ensure that expenditures do not fall out of line with the country’s capacity to generate revenues. A clear fiscal rule that limits spending and the deficit could also be helpful. On the revenue side, there is relatively limited space to increase direct taxes, due to recent cuts in personal income taxes and social security contribution rates. Hence, efforts could focus more on broadening the tax base. Finally, broad structural reforms aimed at making labor and product markets more efficient are crucial to increase the level of potential GDP in the long-run, thus helping generate additional revenues and lowering the country’s debt burden.
20. The comprehensive balance sheet could be used to assess policy plans and strengthen communication of policy messages to the public. They could be published and updated yearly, perhaps in the budget document, to show how net worth is evolving over time. Policy makers can also use this tool to assess and present planned policy changes to voters. For example, the government’s proposed measures to broaden the tax base and limit discretionary expenditure growth, estimated to yield about ¼ percent of GDP permanent improvement in the primary balance, have already reduced the negative net worth of the public sector by more than 10 and 30 percent of GDP under the finite-horizon, and the infinite-horizon measure, respectively. This can indicate to the public that: (1) a relatively small short-run, permanent adjustment can have significant long-run benefits; but (2) the package needs to be complemented with other, more significant measures to ensure intertemporal solvency. Further pension reforms, including of uniformed personnel and farmers, and equalizing the retirement age, could entail additional long-run savings that would usefully serve to further reduce the negative net worth of the public sector. However, definitional changes, or the proposal to lower payments to the private pension funds in an effort to lower short-run headline deficits would not have any impact on intertemporal net worth, as long-run liabilities resulting from pension payments that would need to be made remain unchanged.
21. Nevertheless, this tool should be used and interpreted with some caution. In contrast to traditional indicators, which can be easily measured according to well-established methodologies, the comprehensive public sector balance sheet is based on a series of assumptions regarding long-run growth, the interest rate, as well as estimates of long-run costs that are subject to large uncertainty. As such, the net worth point estimates obtained depend on the underlying assumptions. In Poland’s case, the results appear fairly robust to the macroeconomic assumptions used, as indicated by the sensitivity analysis. Still, it should be noted that fiscal costs from population aging could be higher, if pressures arise to increase pensions and finance them from the budget, which could lead to a larger negative net worth.13 Therefore, what should be emphasized when using the comprehensive balance-sheet methodology is not as much the precise point value obtained, but rather its sign, order of magnitude, and the direction in which it is evolving over time as a result of economic developments and national policies.
Ceccheti, Stephen, M.S.Mohanti, and FabrizioZampolli (2010), “The Future of Public Debt: Prospects and Implications,”BIS Working Paper No. 300, http://www.bis.org/publ/othp09.pdf
European Commission (2009), Sustainability Report 2009, European Economy 9/2009.
Gokhale, Jagadeesh (2009), “Measuring the Unfunded Obligations of European Countries,” National Center for Policy Analysis, Policy Report No. 319, http://www.cato.org/people/jagadeesh-gokhale
Milesi-Ferretti, Gian Maria and KenjiMoriyama (2004), “Fiscal Adjustment in EU Countries: a Balance Sheet Approach,”IMF Working Paper No. 04/143, http://www.imf.org/external/pubs/cat/longres.cfm?sk=17507.0
Traa, Bob (2009), “A Fiscal Early Warning System Based on the Comprehensive Public Sector Balance Sheet,” Greece Selected Issues, IMF Country Report No. 09/245,http://www.imf.org/external/pubs/cat/longres.cfm?sk=23170.0
Traa, Bob, and DeliaVelculescu (2010), “Some Uncomfortable Arithmetic Regarding Europe’s Public Finances,”forthcomingas an IMF Working Paper
von Hagen, Jurgen and Wolff, Guntram B. (2006), “What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU,”Journal of Banking & Finance, Elsevier, vol. 30(12), pages 3259-3279, http://ideas.repec.org/p/trf/wpaper/148.html
22. The intertemporal budget constraint (solvency condition) tests the ability of the government to meet its net debt obligations (or current net worth) with a stream of future primary surpluses. For solvency to hold at a given point in time, future primary surpluses have to be equal to or larger than the current net worth at that point in time (NWt):
where PBt are the primary balances at each point in time (government receipts minus expenditures net of interest payments), discounted over time by the nominal interest on debt it.
This inequality can be expressed in percent of GDP as:
where gt is the nominal growth rate of GDP, with 8 t being the growth-adjusted time-varying discount factor.
If the discounted sum of future primary surpluses exceeds the current net worth, the budget constraint is satisfied. If future primary surpluses fall short of cnw, then current fiscal policies would require strengthening to meet the government’s solvency condition.
23. The infinite-horizon intertemporal net worth is defined as the difference between the discounted sum of future primary surpluses under current policies and current net worth. For simplicity, current net worth only takes into account the financial assets and liabilities of the state (thus excluding public sector capital stock etc., which in theory should be included, but for which data is scarce or even unavailable).. This can be positive or negative, depending on whether current policies are enough to generate (or not) sufficient primary surpluses in the future to cover current net worth.
24. A finite horizon inw* can be defined as the difference between the discounted sum of future primary surpluses under current policies over a specific period of time, and current net worth. Defining such a measure over a foreseeable period rather than over an infinite period may be easier to grasp by the general public (voters). Moreover, it will help avoid time-consistency problems, and thus strong incentives to postpone painful policies into the (far) future, which plague infinite-horizon budget constraints that, theoretically, could be satisfied by very high levels of short-term debt and deficits, as long as there is reason to believe that sufficiently large primary surpluses will be achieved afterwards. The finite horizon inw up to 2060 is therefore defined as:
Hence, the finite horizon inw* is related to its infinite horizon counterpart directly. If it can be assumed that from 2060 onward, the nominal interest rate, GDP growth rate, and the primary balance are constant, and i>g, then inw can be written as:14
Prepared by Delia Velculescu.
The intertemporal budget constraint tests the ability of the government to generate enough primary surpluses into the future to meet its current net debt obligations.
Estonia, Lithuania, Latvia, Slovakia, and Romania have already undertaken measures to this effect. Croatia and Poland have been contemplating similar measures.
See Traa and Velculescu (forthcoming), and Traa (2009).
It, however, does not include liabilities of the financial system (as contingent-claims-analysis models do), nor liabilities resulting from environmental factors.
As presented in the IMF Report for the 2010 Article IV Consultation with Poland.
Real GDP growth is assumed to converge to the EC’s estimated value by 2025 (2.5 percent of GDP) and to follow the path estimated by the Commission thereafter. The deflator and the real interest rate are equally assumed to converge by 2025 to their respective long-run values (for the latter, to the value of growth plus 100 basis points).
The EC’s yearly projected differential is added to the latest IMF projection (2015) to obtain the long-run series.
See Traa and Velculescu (forthcoming) for a description of the methodology and a discussion of results for the EU-27.
These measures are similar in spirit to the EC’s S1 and S2 indicators. They differ from those in as much as the underlying assumptions are different. As Traa and Velculescu (forthcoming) show, parametric measures of intertemporal net worth can also be directly obtained from the S1 and S2 indicators. In the case of Poland, these are estimated at about -125 and -170 percent of GDP for the finite and infinite horizon measures, respectively, somewhat higher than those estimated here mainly due to the EC’s higher assumed medium- and long-term primary deficit, which does not include the recently announced measures.
This is because replacement rates are projected to decline significantly from over 50 percent now to about 30 percent by 2060, while the number of elderly will exceed that of the working population by 2060. This raises interesting political economy questions about the sustainability of the sharp decline in replacement rates, especially if a “war of generations” will develop and lead to fiscal pressures to raise pensions (I am thankful to Krzysztof Rybinski for this point).
Here sums are approximated with integrals: