Discussion

The excellent chapter by Jagadeesh Gokhale tries to answer the crucial question on how the EU countries should cope with ageing populations in the euro area characterized by centralized monetary policy and decentralized fiscal (economic) policies. The author draws on his extensive research in the area of intertemporal allocation of resources and its implications for the design of sustainable pension policies. This issue is highly topical in the face of population ageing in the coming decades

worldwide and especially in Europe. In particular, the reform of the EU’s fiscal framework, the Stability and Growth Pact (SGP) underscores the importance of appropriately catering for long-term sustainability concerns also in the medium-term budgetary policy-making process. In more practical terms, the chapter focuses on fiscal imbalances measures. A similar measure, though with some differences, is regularly used in the EU’s analysis of long-term fiscal sustainability (called the S2 sustainability gap indicator; see European Commission 2006). With regard to the results in the chapter, it should be noted that the chapter’s estimated

fiscal imbalance of some 8 per cent of GDP (about 7 percentage points due to implicit debt and about 1 point due to explicit debt) is considerably higher than the Commission’s estimate of 3.5 per cent of GDP (according to the so-called S2 sustainability gap indicator consistent with respecting the intertemporal budget constraint of the government over an infinite horizon). An important source of difference could be the assumption of ‘current policies’. Gokhale appears to assume that the tax/benefit structure of age and gender remains unchanged over time (a preliminary assumption that may need to be modified). The Commission’s data allow splitting the projected increase in the pension expenditure ratio in the EU. While the old-age dependency effect is very strong, reflecting the projected strong increase in the old-age dependency ratio (doubling in the period to 2050), this is to a considerable degree offset by a notable decrease in the benefit ratio (i.e. average pensions in relation to GDP per worker) and also to some extent by lower take-up ratio (see again European Commission 2006). This results from the fact that the EU’s long-term budgetary projections explicitly model

the institutional settings in each Member State with respect to pensions. In many cases, this implies that public spending on pensions on average will rise slower than average income in the future, due to pension system reforms aimed at exactly containing spending pressures arising from an increased number of older people. The impact of reforms is very important in the EU fiscal surveillance. In particular, with the

reform of the SGP, the medium-term objectives (MTOs) for the government budgetary position should fulfil a triple aim: (i) provide a safety margin with respect to the 3 per cent of GDP deficit limit; (ii) ensure rapid progress towards sustainability; and, (iii) taking account of the

first two, allow room for budgetary manoeuvre and in particular public investment. The MTOs should furthermore be revised when major reforms that improve fiscal sustainability have been undertaken, or at least every four years. It would be an advantage if fiscal indicators reflected the long-term budgetary impact of major reforms and the design of fiscal imbalance indicators therefore was made in such a way that they displayed this desirable property. The fiscal imbalance measure proposed in the chapter could actually underestimate the

sustainability challenge. Indeed, if there is a fiscal imbalance after the last year (i.e. 2051), or if there is an ageing impact also beyond that year, this would not be captured by the measure. This would, as for example in the mainstream US Congressional Budget Office (CBO) calculations, give rise to the ‘rolling window’ problem; when the horizon is extended, an additional imbalance is added. Fiscal indicators for assessing the long-term sustainability of public finances should gainfully reflect the size of the fiscal challenge, or imbalance over the long term. The design of fiscal imbalance indicators could therefore be made in such a way that they avoid possible underestimation of the size of the challenge by opting for an infinite horizon rather than an ad hoc cut-off point, as indeed highlighted in the chapter.