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We are grateful to Alina Carare, Ajai Chopra, Juergen Odenius, Bob Traa, and seminar participants at the IMF’s European Department and at the Ministry of Finance in Berlin for helpful comments and suggestions.
The fiscal-aging cost profile is taken from a long-term fiscal scenario developed in Braumann and others (2006), and is in between a more optimistic scenario by the authorities (Federal Ministry of Finance, 2005; and Werding and Kaltschütz, 2005) and the EU’s Aging Working Group (2¾ percent), and a more pessimistic view expressed by the IFO institute (7¾ percent). Although 4 percent of GDP is used as the baseline projection of aging costs, the sensitivity to alternative estimates is also analyzed.
In addition, the authorities’ are considering health care reform, which could have fiscal implications.
The model has been applied by IMF staff for background work on recent Article IV consultations with Canada, Japan, the United Kingdom, and the United States. See also Bayoumi and Botman (2005), Bayoumi, Botman, and Kumar (2005), Botman and Honjo (2006), Botman and Kumar (2006), and Botman, Edison, and Papa N’Diaye (2006).
The GFM imposes a fiscal reaction function that reestablishes debt sustainability only in the very long run. The simulations in this paper focus on benefits over a shorter policy horizon (until 2050).
Negative consumption growth effects in 2007 could be larger than indicated in the model, as GFM does not include anticipation effects in consumption ahead of the VAT hike (no consumer durables in the model).
The model also understates the sensitivity of investment to taxation as capital is not internationally mobile.
Which is the case for tc = tw/(1- tw).
This policy package assumes a combination of the following measures in percent of GDP: in 2008, ½ percent reduction in government consumption; in 2009, ½ percent of labor income tax base broadening; in 2010, ½ percent of reduction in government transfers; and in 2011, ½ percent from a combination of cutting transfers and raising the effective VAT rate.
Abstracting from the fact that other countries also face aging problems, fiscal difficulties are set to be compounded on a global scale.
Again, this assumes that Germany is tackling aging pressures in isolation. In reality, other countries may also be expected to reduce aging costs. To the extent that this induces global fiscal adjustment, global growth could slow, and the external current account of countries could swing either way, depending on their relative adjustment effort. At the same time, interest rates in Germany and other countries would be expected to decline by more.