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Prepared by Dennis Botman (FAD) and Stephan Danninger (EUR).
The fiscal aging cost profile is taken from a long-term fiscal scenario developed IMF Country Report 06/17, and is in between a more optimistic scenario by the authorities (Federal Ministry of Finance 2005, 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 with potential 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.
The GFM imposes a fiscal reaction function that re-establishes 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.
This policy package assumes a combination of the following measures in percent of GDP: 2008 ½ percent reduction in government consumption, 2009 ½ percent of labor income tax base broadening, 2010 ½ percent of reduction in government transfers, and 2011 ½ percent from a combination of cuts in transfers and raising the effective VAT rate.
Abstracting from the fact that other countries also face aging problems fiscal difficulties are set to compound on a global scale.
Again, this assumes that Germany is the 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 rate in Germany and other countries would be expected to decline by more.
The long-term debt projections in GFM are by 20–30 percentage points of GDP lower than long-term fiscal projections obtained reported in the accompanying Staff Report (Figure 12). Most of this discrepancy can be explained by the larger, endogenous, decline in the real interest rate in GFM following lower debt.