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Fiscal sustainability: Must the problem be diminished before we can see it?

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    Abstract

    Assessments of fiscal sustainability (FS) problems should be based on present values of government revenues and expenditures over an infinite horizon. The paper shows that realistic assumptions imply that the growth rate of government expenditure components may exceed both the steady state growth rate of the economy and the relevant discount rate, which makes the FS problem immeasurably large. The common practice of ad hoc exogenous alignment of government expenditures to the steady state growth path after some distant year may significantly diminish the FS problem, since the effective discounting is likely to remain low. Low effective discounting also makes the FS assessment highly non-robust, reducing its political relevance. It suggests that the fiscal sustainability should be improved by reducing the growth rates of government expenditures, a strategy followed in e.g. the Swedish pension reform.

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    Bibliographic Info

    Paper provided by Research Department of Statistics Norway in its series Discussion Papers with number 499.

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    Date of creation: Apr 2007
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    Handle: RePEc:ssb:dispap:499

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    Keywords: Fiscal sustainability; long run projections; discounting;

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    1. Beetsma, Roel & Bettendorf, Leon & Broer, Peter, 2003. "The budgeting and economic consequences of ageing in the Netherlands," Economic Modelling, Elsevier, vol. 20(5), pages 987-1013, September.
    2. Benz, Ulrich & Fetzer, Stefan, 2004. "Indicators for Measuring Fiscal Sustainability: A Comparative Application of the OECD-Method and Generational Accounting," Discussion Papers 118, Institut für Finanzwissenschaft, Albert-Ludwigs-Universität Freiburg.
    3. Cronin, David & Daniel McCoy,, 2000. "Fiscal Sustainability When Time is on Your Side," Research Technical Papers 4/RT/00, Central Bank of Ireland.
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    8. Thai-Thanh Dang & Pablo Antolín & Howard Oxley, 2001. "Fiscal Implications of Ageing: Projections of Age-Related Spending," OECD Economics Department Working Papers 305, OECD Publishing.
    9. Torben M. Andersen & Lars Haagen Pedersen, 2006. "Financial Restraints in a Mature Welfare State--The Case of Denmark," Oxford Review of Economic Policy, Oxford University Press, vol. 22(3), pages 313-329, Autumn.
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    11. Feldstein, Martin, 2005. "Structural Reform of Social Security," Scholarly Articles 2794830, Harvard University Department of Economics.
    12. William D. Nordhaus, 2006. "The "Stern Review" on the Economics of Climate Change," NBER Working Papers 12741, National Bureau of Economic Research, Inc.
    13. K. Mc Morrow & W. R�ger, 2002. "EU pension reform - An overview of the debate and an empirical assessment of the main policy reform options," European Economy - Economic Papers 162, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
    14. Jagadeesh Gokhale & Kent Smetters, 2005. "Measuring Social Security's Financial Problems," NBER Working Papers 11060, National Bureau of Economic Research, Inc.
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