Federal Ministry of Finance, Berlin, 2005, “Bericht zur Tragfähigkeit der Öffentlichen Finanzen” (Long-Run Fiscal Sustainability Report).
International Monetary Fund, 2002, “Germany: 2002 Article IV Consultation—Staff Report: Staff Supplement; and Public Information Notice on the Executive Board Discussion.” Staff documents published on the Fund’s web site.
Kraemer, Chambers, and Merino, 2005, “In the Long Run, We Are All Debt: Aging Societies and Sovereign Ratings ” S&P Research Note, 18 March, 2005.
Werding, Martin and Anita Kaltschütz, IFO, Munich, 2005, “IFO Beiträge zur Wirtschaftsforschung—Modellrechnungen zur Langfristigen Tragfähigkeit der Öffentlichen Finanzen.”
Prepared by Bob Traa. I would like to thank Mrs. Velleuer at the Ministry of Finance, Mr. Werding and Ms. Kaltschütz at IFO, and seminar participants at the Bundesbank and Ministry of Finance for their helpful comments.
For instance, the real interest rate on the debt is assumed to be constant in future years, even when the debt rises significantly. This is a simplifying but not a realistic assumption.
The population projections used for the growth exercise are from the 2003 demographic forecasts prepared by the German Institute of Statistics—the middle scenario (“5”). It assumes an annual net immigration of 200,000 persons. The population is projected to drop from 83 million persons in 2005 to 75 million in 2050. Alternatively, the highest and the lowest population growth scenarios (with higher and lower fertility and immigration, respectively) result in projections of about 9 percent more or fewer persons (81 and 67 million, respectively) by 2050—the end of the projection period.
Nevertheless, it abstracts from risk premia that are likely to emerge if debt swells to levels that are considered unsustainable.
We return to this important assumption in paragraph 44 below.
The panel shows the total dependency ratio (including children below 15 and the elderly over 65 years of age) to allow both pension and education spending effects. The old-age dependency ratio (over 65 in relation to the working age population), rises even sharper and would be a better benchmark when analyzing pension pressures in isolation.
Standard and Poor’s recently published an analysis for the G-7 countries, including Germany, suggesting that the federal credit rating for long-dated bonds would likely be downgraded to junk status in the 2020s on the basis of rapidly rising debts if current policies were maintained over the long run. See Kraemer, Chambers, and Merino, 2005.
From the equation indicating debt-ratio dynamics, ∂d = d.*[i-y] – p, where ∂d indicates the change in the debt ratio, d. is the debt ratio at the end of the previous period, i and y are the interest rate and GDP growth rates, and p is the primary surplus, one can calculate what p would need to be in any given year to stabilize the debt ratio, i.e., ∂d = 0. Since in Germany, the interest rate is projected to be higher than the growth rate in every future year (Figure 1), the authorities need a primary surplus of certain minimum magnitude to stabilize the debt ratio. Any primary deficit in any year would further increase the debt ratio.
Germany’s unemployment rate has been above 8 percent of the labor force for some 15 years, and the staff’s 8 percent estimate for the NAIRU is shared by some labor specialists in Germany. To reduce the NAIRU to 3.3 percent, as is assumed in the Long-Run Fiscal Sustainability Report, would require further labor market liberalization and changes in relative prices of labor, especially for elderly workers and those with lower productivity.
It is not certain that fewer pupils means lower costs. First, lower density of pupils can actually increase education costs (because of reduced economies of scale). Second, Germany has higher student/teacher ratios than average in the OECD. Savings may thus be allocated to lower this ratio to improve the quality of education. Lastly, industrial countries need to increase human capital if they are to compete effectively in higher-value-added markets (the lower-value-added markets are increasingly dominated by lower-cost countries). Increasing human capital is expensive.
“A Preliminary Public Sector Balance Sheet” and its implications are presented in the next chapter of these selected issues papers.