Germany: Selected Issues

This Selected Issues paper attempts to analyze the end-point problem and improve the quality of potential GDP estimates for Germany. It projects that Germany’s potential GDP growth will slow over the coming decade, mainly because of declining labor input. The paper focuses on a long-term fiscal scenario for Germany based on current policies. The paper also attempts to construct a preliminary public sector balance sheet for Germany, and analyzes the performance of its nonfinancial corporate sector.

Abstract

This Selected Issues paper attempts to analyze the end-point problem and improve the quality of potential GDP estimates for Germany. It projects that Germany’s potential GDP growth will slow over the coming decade, mainly because of declining labor input. The paper focuses on a long-term fiscal scenario for Germany based on current policies. The paper also attempts to construct a preliminary public sector balance sheet for Germany, and analyzes the performance of its nonfinancial corporate sector.

II. Germany:A Long-Run Fiscal Scenario Based on Current Policies4

A. Introduction

27. A fiscal baseline scenario is a simulation of what might happen to the government fiscal balance and public debt if policies remain as they are today. Such a scenario is useful because it offers insight whether the current set of policies would be sustainable under well-specified assumptions. If the long-run public finances appear unsustainable, the baseline scenario can help to provide direction to the adjustment that might be required to achieve sustainability.

28. Constructing a baseline scenario is not an exact science. Assumptions need to be made about future movements of important macroeconomic and fiscal variables. Moreover, in this paper, the underlying model is kept simple. This makes the exercise tractable, and focuses the discussion on the key assumptions and outcomes, but it does not treat at length complicated interactions that might exist within the economy and that over time may become important.5 Nevertheless, even a straightforward exercise with some analytical rigor can be valuable to stimulate an informed discussion. As such, the estimates are not intended as predictors of the future. Rather, they serve to illustrate the potential scope of the deterioration in fundamentals that could occur unless corrective policy action is taken. An advantage of keeping the model tractable is that this makes the exercise accessible to a wider audience, which helps foster a better appreciation why adjustment policies are necessary.

29. This paper is organized as follows: section B first presents the assumptions about baseline indicators and some details used to construct the model, and then presents the results for the baseline scenario. This is then compared with an optimistic scenario in Section C. Section D provides some comparisons of this analysis with alternative long-run public finance scenarios prepared recently by the IFO Institute in Munich for the Federal Ministry of Finance (see Werding and Kaltschütz, 2005; and the Fiscal Sustainability Report 2005 prepared by the Federal Ministry of Finance). Section E concludes with some policy considerations.

B. Main Assumptions and Results

Main baseline indicators and assumptions

30. The main macroeconomic indicators and assumptions underlying this baseline scenario are depicted in Figure 1 and Table 1:

Figure 1.
Figure 1.

Germany: Macroeconomic Indicators and Assumptions for the Fiscal Baseline Scenario, 2000-50

(In percent)

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Source:Data provided by the authorities;and Fund staff calculations.
Table 1.

Germany: Baseline Scenario, Including 2005 Budget Measures

article image
Source: IMF staff calculations.
  • Potential real GDP growth. Germany is subject to aging and population decline over the next several decades.6 This is a driving force behind gradually slowing output growth. The analysis in “Long-Run Growth in Germany” in this volume of selected issues papers suggests that potential real GDP growth is likely to slow from around 1¼ percent a year today to 1 percent a year in the next few decades (assuming that the unemployment rate will drop to the NAIRU of around 8 percent in the steady state). This implies a long-run per capita potential output growth of 1-1½ percent a year.

  • output gap. Current economic activity is below potential output, with the gap estimated at about 1 percent. Growth is assumed to rise above potential in the next few years so that the output gap is closed by the end of the decade. After it closes, the model assumes that actual output follows the path of potential output.

  • Inflation and nominal GDP growth. German inflation has been below the European average. As the output gap closes, the scenario assumes that inflation in the GDP deflator will drift up to 1¾ percent a year. Combined with long-run potential real GDP growth, this implies that nominal GDP growth is seen to remain slightly below 3 percent a year in future. This rate is lower than in the past, and puts limits on public sector deficits that can be absorbed by the economy.

  • Interest rates. With the recent slowing of activity and the rise in saving, marginal interest rates on newly placed debt have been falling. Indeed, the average implicit interest rate on the entire gross public debt has declined from 5.6 percent in 2000 to 4.7 percent in 2004. Similarly, the average implicit real interest rate on the debt (deflated by the implicit GDP deflator) also has fallen considerably. For the future, this baseline scenario assumes that the average real interest rate settles at 3.2 percent a year. This is higher than the real GDP long-run growth rate, and reflects Germany’s integration in world capital markets.7 The average nominal interest rate is then just below 5 percent.

31. Figure 2 shows two additional important assumptions in the baseline scenario:

Figure 2.
Figure 2.

Germany: Public Finance Indicators for the Fiscal Baseline Scenario, 2000-50

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Sources: Data provided by the authorities; and Fund staff calculations.
  • social security revenue. The top left panel indicates that social security revenue has been falling lately in percent of GDP. This reflects the falling share of wage income in output—the wage bill is the base for social security revenues. We assume that the wage share in national income stops declining when the output gap closes in 2010, and that social security contribution rates are held constant.8 The latter avoids negative effects on labor supply and helps to calculate the implicit liabilities obtained in the entitlement system. This implies that social security revenue will stabilize in relation to GDP.

  • Entitlement spending. Aging will lead to increased spending on pensions, civil service retirement outlays, health care expenditure, and long-term care provisions. At the same time, expenditures on education and unemployment may fall as the fraction of young people in society declines and the rate of unemployment adjusts to the NAIRU when the output gap closes. Estimates of the total increase in entitlements are the key drivers behind long-run fiscal developments. Such estimates were first presented in the October 2002 Staff Report for the German Art. IV Consultation and they suggested that the entitlement pressures could add 6½ percent of GDP to primary fiscal expenditure by 2050. After the measures of Agenda 2010, this staff baseline assumes that about 4 percent of GDP of these long-run pressures remain, as summarized below in the text table in paragraph 41. The increase in spending is assumed to follow a path in proportion to the rise in the overall dependency ratio as shown in the top right panel of Figure 2.9

32. The projections can now be completed with two final fiscal assumptions:

  • Tax and nontax revenue. The tax ratio has been falling in recent years, reflecting the policy of graduated cuts in income tax rates. The model includes a small further loss in income tax pressure in 2005, because of the last step in the income tax cuts, and the planned corporate income tax cut. Beyond that, the model assumes that revenue remains constant with any rate cuts being offset by base broadening.

  • other primary expenditure. The public sector wage bill, and spending on goods and services and capital are kept constant in percent of GDP for the long run.

Some preliminary results

33. Figure 3 summarizes the main results of the projections. Recently, the primary fiscal balance has turned from a surplus of 2 percent in 2000 to a deficit of 0.6 percent of GDP in 2004. Looking ahead, primary expenditure will rise with demographic pressure through 2036, before starting to decline gradually after the main effects of aging have passed. The divergent trends between revenue and expenditure cause a sharp widening in the primary deficit to almost 6 percent of GDP in 2036, followed by a slow decline to below 5 percent by 2050 (middle panel).

Figure 3.
Figure 3.

Germany: Revenue, Expenditure, and Primary Balance for Baseline Scenario, 2000-50

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Source:Data provided by the authorities;and Fund staff calculations.

34. The bottom panel of Figure 3 suggests that current fiscal policies are unsustainable.10 With the deteriorating primary balances in the baseline projection, and a growing annual interest bill, the overall general government balance would register widening deficits and the debt ratio would steadily increase to above 350 percent of GDP by 2050. As the figure suggests, in the current decade, the increase in the debt/GDP ratio would seem relatively subdued. However, after 2010 the primary balances would start to deteriorate, and the interest bill on the growing debt stock would accelerate—the debt ratio would then begin to climb at a faster pace as well.

35. The model allows to calculate what the primary balance would have to be in any given year to stabilize the debt ratio.11 This “required” set of primary surpluses is shown in the left bottom panel of Figure 2 For example, in 2006 the primary deficit is currently projected to be 0.4 percent of GDP (the solid line). The primary surplus required to stabilize the debt ratio would be 1.6 percent of GDP (the dashed line). Therefore, to step onto a path of fiscal sustainability at the debt ratio of end-2005 would require, in the 2006 budget, permanent fiscal adjustment measures of 2 percent of GDP. Since the gap between projected and “required” primary balances is widening in the future, postponing adjustment measures to close this “sustainability gap” leads to ever-larger measures that would be needed to stabilize the debt ratio from its level of end-2005.

36. After an initial adjustment, additional but smaller adjustments would have to follow in subsequent years to keep the debt ratio stable. Even if Germany were to take 2 percent of GDP in permanent measures in the 2006 budget, further entitlement spending growth in next years (driven by demographics) would lower again the primary surplus below its required level. Thus, rising entitlement spending would require further primary measures in each subsequent year to pay for them. The lower right hand panel in Figure 2 shows what these annual adjustments would have to be: they tend to fall within 0-½ percent of GDP a year. Those annual adjustments would exactly offset the cumulative spending pressures on the debt ratio as the effect of aging on the public finances evolves.

37. The required cumulative adjustment appears substantial. The gap between the “required” and projected primary balances in the lower left hand panel of Figure 2 suggests that Germany needs 11.8 percentage points of GDP in cumulative adjustment through 2050 to stabilize the debt ratio at its level of end 2005. Over 44 years, this is 0.3 percent of GDP a year on average. Fund advice for the next few years to aim for annual structural adjustments of ½ percent of GDP therefore remains sensible, as falling further behind on the adjustment path would be costly.

C. Assumptions and Results of an Optimistic Scenario

38. Figures 4 and Figure 5 show the assumptions and results of an optimistic scenario. It differs from the baselinescenario in the following ways:

  • Higher employment and lower unemployment. Instead of a constant unemployment rate of 8 percent as in the baseline scenario, the optimistic scenario assumes a decline to 3.3 percent in the long run.12

  • Higher GDP growth. As labor input increases, real GDP is higher than in the baseline scenario. The inflation projection is not altered.

  • Smaller increase in entitlement spending. With lower unemployment, the outlays for unemployment insurance decline significantly (see comparison table in paragraph 41). As a result, the increase in total entitlement spending would now be limited to 2.6 percent of GDP by 2050, rather than 4.0 percent as in the baseline.

  • The projected and “required” primary deficits are now lower. The cumulative fiscal adjustment required to stabilize the debt-GDP ratio is now 7 percentage points, rather than 11.8 percentage points in the baseline scenario. The bottom-right panel of Figure 4 shows that this corresponds to an average annual adjustment effort of 0.2 percent of GDP, compared with 0.3 percent in the baseline scenario.

Figure 4.
Figure 4.

Germany: Optimistic Scenario, 2000-50

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Source: IMF staff calculations.
Figure 5.
Figure 5.

Germany: Fiscal Projections under the Optimistic Scenario, 2000-50

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Source: IMF staff calculations.

39. But even the optimistic scenario is still unsustainable. As Figure 5 indicates, the fiscal balance would still deteriorate, and the debt ratio would increase steadily. However, the sharp acceleration in the debt-ratio would be delayed by about ten years.

D. Some Comparisons with Estimates Prepared by the IFO Institute and Presented in the Authorities’ Long-Run Fiscal Sustainability Report

40. A recent technical background study prepared by IFO for the authorities’ fiscal sustainability report reaches similar conclusions as this paper: even under more favorable scenarios, current fiscal policies need to be strengthened to avoid debt problems in future. We can briefly review the main differences in assumptions and results. Referring to the baseline scenarios presented by IFO and in this note, some key issues are:

  • Employment grows faster in the IFO/official baseline. Indeed, the IFO assumes in its baseline scenario that the unemployment rate gradually declines to 3.3 percent of the labor force. Instead, this paper considers this assumption optimistic given current relative factor prices and structural rigidities in the labor markets.

  • Real GDP growth is faster in the IFO/official baseline—consistent with its different assumption on labor utilization.

  • Labor productivity is comparable in the long run in both studies. The staff sees productivity growth evolving somewhat more gradually to its long run steady state of about 1¾ percent a year.

  • Real interest rates are slightly higher in the IFO/official baseline (3.5 versus 3.2 percent, respectively).

  • The starting fiscal balances. The IFO scenarios assume that the authorities will adhere through 2008 to the government’s medium-term fiscal plan (Mittelfristiger Finanzplan). However, the plan is off-track and this paper thus calculates its baseline from 2005 onward on current policies that suggest larger near-term deficits as compared with those included in the official plan.

Key Assumptions and Results for the Macroeconomic Framework for the Period 2005-50

article image
Sources: IFO; and Fund staff calculations.

Millions of persons.

Annual percent change in real GDP per employee.

Percent, in real terms.

41. There are also some differences in the assumptions for pressures on entitlement expenditures in the two studies:

  • Aging costs and unemployment in the baseline scenarios. In its baseline scenario, the IFO study sees the subtotal costs of aging growing by 4.9 percentage points of GDP through 2050. This amount is partly offset by lower costs for schooling (fewer persons of school age in future),13 and by lower costs for unemployment insurance for a total spending increase of 2.6 percent of GDP by 2050. The staff baseline has unemployment dropping less, so the saving from unemployment insurance is also less, and the total increase in expenditures is the 4 percent of GDP noted earlier.

  • Aging costs and unemployment in the risk and optimistic scenarios. The IFO study notes that its baseline may be somewhat optimistic and that it may underestimate the costs from aging and unemployment. Therefore, IFO presents a risk scenario with higher aging costs and a smaller drop in unemployment (to around 7 percent of the labor force). This would cause additional total spending pressures by 2050 of 4.9 percentage points (rather than 2.6). Alternatively, it can now be seen that the staffs optimistic scenario described above closely corresponds to the IFO baseline scenario—with additional spending pressures by 2050 limited to 2.6 percent of GDP.

Additional Public Sector Spending by 2050 1 /

article image
Sources: IFO; and Fund staff calculations.

Level is outlays in percent of GDP, scenarios reflect further increase by 2050.

Baseline scenario and risk scenario, respectively.

Baseline scenario and optimistic scenario, respectively. For ease of comparison, the optimistic scenario focuses on lower unemployment costs only.

42. The conclusions from these comparisons point in the same direction for fiscal adjustment. The IFO/official baseline scenario may be somewhat optimistic; hence, it is complemented with a risk scenario. The staff baseline scenario may be somewhat pessimistic; hence, it is complemented with an optimistic scenario. Nevertheless, all scenarios point to a need for additional fiscal adjustment if Germany is to prevent the debt-GDP ratio from rising to unsustainable levels.

E. Some Policy Considerations and Other Key Aspects

43. Many in Germany recognize that aging requires further policy measures, but agreeing on the precise balance of measures is understandably difficult. Choices need to be made between the weights on tax increases versus expenditure cuts; policy options need to be further identified and carefully quantified, and explained to the public; and there are a host of other key aspects, such as the role of onetime measures and the distributional impact of adjustment that enter into discussion. This last section touches briefly on these issues.

44. Raising taxes or cutting expenditures? Germany will likely need a combination of tax increases and expenditure cuts to absorb the costs of aging and unemployment. Levying the required adjustment only on expenditure or only through tax increases (exploring either corner solution, so to speak) would have wide-ranging distributional impacts and be politically very difficult. Also, certain solutions may be economically inconsistent. For instance, while the social security system has built-in stabilizers to drive up social security contributions, the associated higher payroll taxes could reduce significantly the labor supply—and hence potential output growth. The IFO study estimates that the magnitude of the required increase in payroll taxes is very high—around 8 percentage points for the aging effects (as shown below), offset only partly by saving from the unemployment insurance fees (which in any event seem less likely). Such sharp increases in payroll taxes should be avoided. Indeed, both the IFO/official baseline and this paper exclude for now further increases in payroll taxes.

Potential Increase in Payroll Tax by 2050 1

article image
Source: IFO.

Percentage points of taxable wage income.

Base scenario and risk scenario, respectively.

45. Some alternative measures could be considered. Using detailed information from various agencies and ministries, the IFO has estimated how some proposed alternative adjustments might be able to reduce expenditures by 2050.

Possible Impact of Some Adjustment Proposals

article image
Source: IFO, 2005.

Projected reduction in expenditure pressures in percentage points of GDP by 2050.

Assumes constant morbidity and no advances in medical technology. If recent trends in these variables continue the net savings by 2050 would be zero.

  • Increasing the retirement age by 1 month a year until it reaches 67 is projected to lower pension expenditures by 2050 by 0.3 percentage points of GDP. This proposal has been made by the Rürup Commission and is under study by the government.

  • Reducing indexation of some health and long-term care benefits is also under study and could provide significant expenditure savings over time. However, IFO points out that the (typical) baseline assumptions of constant morbidity and health technology are likely incorrect. It points out that if these variables evolve in future on trend, the cuts in outlays would likely just serve to offset the pressures already in the pipeline.

  • The assumption on education spending in the baseline may be too optimistic, since investments in human capital in future will likely require additional funds. Thus, the savings from lower volume (fewer school age children) in the calculations above would be converted into higher per pupil spending.

  • Finally, IFO examines a path of substantially lower discretionary spending, but the exact areas where to cut are not specified.

These options do not include explicitly possible further cuts in tax expenditures and subsidies. The Koch-Steinbrück Commission reported that spending on subsidies and tax exemptions may comprise as much as 6 percentage points of GDP. They reflect allocations that are a part of the “welfare state” for families and corporations and also need to be rethought for long-run sustainability.

46. Besides the quantification of precise measures, some other key aspects will need to be taken into account:

  • Onetime adjustments don’t count. Germany is currently using asset sales and other one-time measures to keep the debt ratio from rising in line with the full deficit. These measures do not alter the primary deficit path because they are not permanent adjustments. Moreover, when seen from the point of view of the public sector net worth, asset sales are as corrosive to Germany’s wealth as debt increases.14

  • Growth matters but is not a panacea. Germany’s difficulties are caused in part by the projection that output growth will remain well below the interest rate. Whenever that happens, countries need to run primary surpluses of a certain minimum just to keep the debt ratio constant (since ∂d = d.*[i-y] - p). Any structural reform that could increase growth (e.g., more hours worked) would dampen the need for primary surpluses and make it correspondingly easier to absorb the costs of aging. At the same time, higher growth is not a panacea because entitlements are broadly indexed to wages. With higher growth, wages will be higher, and so will be entitlement pressures. Indeed, indexing to wages is a crucial cost driver of the welfare state.

  • Income distribution matters. This indexation, or more generally, the distribution of income between capital owners, wage earners, and benefit recipients, is perhaps the most difficult political issue to solve. In the 1960s and 1970s, when the modern welfare state was created, income was significantly redistributed from capital owners to wage earners and benefit recipients. More recently, with the onset of wage moderation, and under pressure from globalization, the pendulum has begun to swing back from wage earners and benefit recipients to capital owners. The effects of the initial large shift, when the welfare state was created, was difficult to discern because the economy was growing rapidly, the population was rising, and benefit recipients were relatively few so that the main costs would become visible only later. Germany has now arrived at this “later” stage, characterized by a rising dependency ratio. Thus it is possible that promises under the welfare state had overshot, and that income distribution needed to be recalibrated again to regain overall sustainability. Reducing welfare benefits in its different manifestations (including corporate and family subsidies alongside entitlement spending) seems necessary to save the welfare state.

  • Finding the right balance is difficult. Figure 6 shows the implied income distribution of the staffs baseline scenario and the effects of recent adjustment measures. In the past few years, wage shares have been falling, and benefits have been scaled down. Thus, between 2000 and 2006, the level of benefits per recipient has been slowing while the economy generated moderate increases in overall per capita incomes. Virtually all these income gains have been accruing to capital—because wage incomes have been flat. This temporary “deindexing” of benefits from per capita incomes has generated fiscal savings. However, the policies to get there have been very difficult to implement. Further adjustments to the welfare state are needed. This will require a strong political consensus.

Figure 6.
Figure 6.

Germany: Distributional Indicators for the Staff Baseline Scenario 1/

Citation: IMF Staff Country Reports 2006, 017; 10.5089/9781451810509.002.A002

Sources: Data provided by the authorities; and Fund staff calculations.1/ These distributional indicators must be interpreted as indicative, because the baseline scenario is financed with debt and is therefore not sustainable. Real entitlements and/or real wages will need to be reduced to limit the debt.

47. It follows that a substantive discussion is required to make some difficult choices. The discussion should be positive and forward looking, and could address the following three concluding remarks:

  • Solutions are possible. Germany is not without options, as shown by the magnitudes in the Koch-Steinbrück list, the quantified measures in the IFO list above, and the adjustments already made in Agenda 2010. The political system, however, will need to make clear choices, explain them in a consistent quantified framework, and then implement them forthrightly.

  • Transparency is essential. The authorities have published a helpful long-run fiscal sustainability report, which demonstrates that further policy adjustments are needed to prevent debt sustainability problems in future. This report should be updated regularly, perhaps following the annual budget debate, and on the basis of policies currently in place, instead of assuming ex-ante success with the medium-term fiscal plan. Indeed, the official projections show less debt pressure in future than the baseline projections of this paper, substantially owing to the assumption that the near-term fiscal plan will be implemented. Implicitly, the difference between the two baselines demonstrates that postponing corrective measures, i.e., falling behind on the plan, is very costly.

  • The challenges could be presented in form of a public sector balance sheet. The large future deficits on current policies are flows that can be discounted and presented as the NPV of implicit future liabilities. It is helpful to show that such implicit debts are large. Also, it could demonstrate that some difficult reforms, which have most of their beneficial effects in the longer-run such as those of Agenda 2010, can make a substantial contribution in reducing the intertemporal inconsistencies. The accompanying selected issues paper explores such a preliminary public sector balance sheet and how it could assist in the policy discussion.

References

  • Federal Ministry of Finance, Berlin, 2005, “Bericht zur Tragfähigkeit der Öffentlichen Finanzen” (Long-Run Fiscal Sustainability Report).

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  • 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.

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  • 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.

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  • Werding, Martin and Anita Kaltschütz, IFO, Munich, 2005, “IFO Beiträge zur Wirtschaftsforschung—Modellrechnungen zur Langfristigen Tragfähigkeit der Öffentlichen Finanzen.

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4

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.

5

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.

6

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.

7

Nevertheless, it abstracts from risk premia that are likely to emerge if debt swells to levels that are considered unsustainable.

8

We return to this important assumption in paragraph 44 below.

9

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.

10

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.

11

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.

12

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.

13

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.

14

“A Preliminary Public Sector Balance Sheet” and its implications are presented in the next chapter of these selected issues papers.

Germany: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Germany: Macroeconomic Indicators and Assumptions for the Fiscal Baseline Scenario, 2000-50

    (In percent)

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    Germany: Public Finance Indicators for the Fiscal Baseline Scenario, 2000-50

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    Germany: Revenue, Expenditure, and Primary Balance for Baseline Scenario, 2000-50

    (In percent of GDP)

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    Germany: Optimistic Scenario, 2000-50

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    Germany: Fiscal Projections under the Optimistic Scenario, 2000-50

    (In percent of GDP)

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    Germany: Distributional Indicators for the Staff Baseline Scenario 1/