Czech Republic: Selected Issues
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International Monetary Fund
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This Selected Issues paper on the Czech Republic presents an analysis of various aspects of population aging: its macroeconomic effects; impact on fiscal sustainability; and implications for private savings. The paper simulates the macroeconomic effects of population aging in the Czech Republic using an overlapping-generations model. It finds that aging can significantly weaken the outlook for economic growth and living standards. The paper evaluates the fiscal implications of aging using a generational-accounting framework. It also evaluates the monetary policy implications of capital account volatility—as the relative importance of portfolio flows increases.

Abstract

This Selected Issues paper on the Czech Republic presents an analysis of various aspects of population aging: its macroeconomic effects; impact on fiscal sustainability; and implications for private savings. The paper simulates the macroeconomic effects of population aging in the Czech Republic using an overlapping-generations model. It finds that aging can significantly weaken the outlook for economic growth and living standards. The paper evaluates the fiscal implications of aging using a generational-accounting framework. It also evaluates the monetary policy implications of capital account volatility—as the relative importance of portfolio flows increases.

I. Introduction and Overview

1. This paper provides background on key issues of the consultation. The first three chapters present an analysis of various aspects of population aging: its macroeconomic effects; impact on fiscal sustainability; and implications for private savings. The last chapter evaluates the monetary policy implications of capital account volatility—as the relative importance of portfolio flows increases.

2. Chapter II simulates the macroeconomic effects of population aging in the Czech Republic using an overlapping-generations model. It finds that aging can significantly weaken the outlook for economic growth and living standards. Although labor market reforms and technological progress can help mitigate the impact on growth, the budget burden of increases in old-age pensions and health care is likely to remain significant.

3. This provides the backdrop for Chapter III, which evaluates the fiscal implications of aging using a generational-accounting framework. It finds that the fiscal position is unsustainable in the long run under current policies. Systemic reform of both age-and non-age-related expenditures will be needed to restore sustainability. Fiscal adjustment needs to be implemented early to minimize its magnitude and ensure that a fairer generational balance is achieved in restoring fiscal sustainability.

4. Chapter IV explores household balance sheets in a comparative perspective. The structure and level of financial assets and liabilities are affected by two main trends in the Czech Republic: convergence to the EU and population aging. Based on behavior observed in financially developed countries, this chapter concludes that households will likely need to shift their wealth from nonfinancial to financial assets. Moreover, the level of financial wealth is expected to increase—in line with overall wealth, and to help deal with the transfer of risks from the public to the private sector as the population ages.

5. Financial flows in the Czech Republic show an increase in the volatility of direct and portfolio investment. This trend is expected to continue, especially as the composition of FDI is likely to shift toward intermediate products and services with lower capital intensity than past FDI. Chapter V analyzes the monetary policy implications of this phenomenon based on a two-region version of the IMF’s new Global Economic Model. The main conclusion is that monetary policy may need to become more responsive to address the macroeconomic variability arising from more volatile flows. However, the difficulty of forecasting the persistence of capital flows in real time calls for caution in responding actively to capital account shocks.

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Czech Republic: Selected Issues
Author:
International Monetary Fund