Assessing Fiscal Risks through Long-term Budget Projections

Long-term budget projections are in their infancy. The method described here is a bottom-up approach to measure future fiscal challenges. The sustainability criteria must be regarded as restrictions of the total fiscal aggregates, confronting bottom-up projections with top-down limits. Uncertainties have often given long-term projections little credibility; sensitivity analysis has to be done. This article discusses the main reasons for uncertainty and how to handle them. In most OECD countries the increase in the elderly population is not only a transitory problem created by high fertility rates after the Second World War. Higher longevity will create permanent higher old-age dependency rates in the future. Some projections even indicate that those rates will increase after the baby-boom generation is gone. Thus it is necessary to consider both how pension reforms are formulated and a broader agenda for reform of the public sector. Given the lower supply of labour, it may be important to modernise the public sector and create less public demand for labour. In many countries, policy reforms will be necessary to create fiscal sustainability to avoid future fiscal risks.