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Population ageing and fiscal sustainability in Finland: a stochastic analysis

  • Lassila , Jukka


    (Research Institute of the Finnish Economy)

  • Valkonen, Tarmo


    (Research Institute of the Finnish Economy)

This study analyses the fiscal sustainability of the Finnish public sector using stochastic projections to describe uncertain future demographic trends and asset yields. While current tax rates are unlikely to yield sufficient tax revenue to finance public expenditure with an ageing population, if developments are as expected, the problem will not be very large. However, there is a small, but not negligible, probability that taxes will need to be raised dramatically, perhaps by over 5 percentage points. Such outcomes, if realised, could destabilise the entire welfare state. The study also analyses three policy options aimed at improving sustainability. Longevity adjustment of pension benefits and introduction of an NDC pension system would reduce the expected problem and narrow the sustainability gap distribution. Under the third option, pension funds would invest more in equities and expect to get higher returns. This policy also limits the sustainability problem, but only under precondition that policymakers in the future can live with substantially larger variation in the value of the funds without adjusting tax rules or benefits.

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Paper provided by Bank of Finland in its series Research Discussion Papers with number 28/2008.

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Length: 71 pages
Date of creation: 03 Dec 2008
Date of revision:
Handle: RePEc:hhs:bofrdp:2008_028
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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  1. Jukka Lassila & Tarmo Valkonen, 2007. "The Finnish Pension Reform of 2005," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan, vol. 32(1), pages 75-94, January.
  2. Settergren, Ole & Mikula, Boguslaw D., 2005. "The Rate of Return of Pay-As-You-Go Pension Systems: A More Exact Consumption-Loan Model of Interest," Discussion Paper 249, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
  3. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  4. Henning Bohn, 2001. "Social Security and Demographic Uncertainty: The Risk-Sharing Properties of Alternative Policies," NBER Chapters, in: Risk Aspects of Investment-Based Social Security Reform, pages 203-246 National Bureau of Economic Research, Inc.
  5. Lassila, Jukka & Valkonen, Tarmo, 2008. "Suomen työeläkejärjestelmän stokastinen kestävyysanalyysi," Discussion Papers 1137, The Research Institute of the Finnish Economy.
  6. Krueger, Dirk & Ludwig, Alexander, 2006. "On the Consequences of Demographic Change for Rates of Return to Capital, and the Distribution of Wealth and Welfare," CEPR Discussion Papers 5834, C.E.P.R. Discussion Papers.
  7. Bohn, Henning, 2002. "Government Asset and Liability Management in a Era of Vanishing Public Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 887-933, August.
  8. Henning Bohn, 2004. "Intergenerational Risk Sharing and Fiscal Policy," 2004 Meeting Papers 22, Society for Economic Dynamics.
  9. Settergren, Ole & Mikula, Boguslaw D., 2005. "The rate of return of pay-as-you-go pension systems: a more exact consumption-loan model of interest," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(02), pages 115-138, July.
  10. John Creedy & Grant M. Scobie, 2005. "Population Ageing and Social Expenditure in New Zealand," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 38(1), pages 19-39, 03.
  11. repec:nsr:niesrd:250 is not listed on IDEAS
  12. Lassila, Jukka & Valkonen, Tarmo, 2001. "Ageing, Demographic Risks, and Pension Reform," Discussion Papers 765, The Research Institute of the Finnish Economy.
  13. Alan J. Auerbach & Ronald Lee, 2006. "Notional Defined Contribution Pension Systems in a Stochastic Context: Design and Stability," NBER Working Papers 12805, National Bureau of Economic Research, Inc.
  14. Mendoza, Enrique G. & Oviedo, P. Marcelo, 2006. "Public Debt, Fiscal Solvency, and Macroeconomic Uncertainty in Latin America: The Cases of Brazil, Colombia, Costa Rica, and Mexico," Staff General Research Papers 12700, Iowa State University, Department of Economics.
  15. Bohn, Henning, 2007. "Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint?," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1837-1847, October.
  16. Jukka Lassila & Tarmo Valkonen, 2004. "Pre-funding Expenditure on Health and Long-term Care under Demographic Uncertainty," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan, vol. 29(4), pages 620-639, October.
  17. Valkonen, Tarmo, 2002. "Demographic Uncertainty and Taxes," Discussion Papers 816, The Research Institute of the Finnish Economy.
  18. Alexander Ludwig & Thomas Schelkle & Edgar Vogel, 2007. "Demographic Change, Human Capital and Endogenous Growth," MEA discussion paper series 07151, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
  19. Alho, Juha M. & Hougaard Jensen, Svend E. & Lassila, Jukka & Valkonen, Tarmo, 2005. "Controlling the effects of demographic risks: the role of pension indexation schemes," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(02), pages 139-153, July.
  20. Pizer, William & Newell, Richard, 2000. "Discounting the Distant Future: How Much Do Uncertain Rates Increase Valuations?," Discussion Papers dp-00-45, Resources For the Future.
  21. Smetters, Kent, 2006. "Risk sharing across generations without publicly owned equities," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1493-1508, October.
  22. Henning Bohn, 2005. "The Sustainability of Fiscal Policy in the United States," CESifo Working Paper Series 1446, CESifo Group Munich.
  23. Lassila, Jukka & Valkonen, Tarmo, 2007. "Longevity Adjustment of Pension Benefits," Discussion Papers 1073, The Research Institute of the Finnish Economy.
  24. Nick Davis, 2001. "Does Crown Financial Portfolio Composition Matter?," Treasury Working Paper Series 01/34, New Zealand Treasury.
  25. Kilponen , Juha & Kinnunen , Helvi & Ripatti , Antti, 2006. "Population ageing in a small open economy – some policy experiments with a tractable general equilibrium model," Research Discussion Papers 28/2006, Bank of Finland.
  26. Geert Langenus, 2006. "Fiscal sustainability indicators and policy design in the face of ageing," Working Paper Research 102, National Bank of Belgium.
  27. Fehr, Hans & Habermann, Christian, 2006. "Pension reform and demographic uncertainty: the case of Germany," Journal of Pension Economics and Finance, Cambridge University Press, vol. 5(01), pages 69-90, March.
  28. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
  29. Alho, Juha M. & Vanne, Reijo, 2006. "On predictive distributions of public net liabilities," International Journal of Forecasting, Elsevier, vol. 22(4), pages 725-733.
  30. Henning Bohn, 2001. "Retirement Savings in an Aging Society: A Case for Innovative Government Debt Management," CESifo Working Paper Series 494, CESifo Group Munich.
  31. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  32. Nick Davis & Richard Fabling, 2002. "Population Ageing and the Efficiency of Fiscal Policy in New Zealand," Treasury Working Paper Series 02/11, New Zealand Treasury.
  33. Pål Ulla, 2006. "Assessing Fiscal Risks through Long-term Budget Projections," OECD Journal on Budgeting, OECD Publishing, vol. 6(1), pages 127-187.
  34. Lee, Ronald & Tuljapurkar, Shripad, 1998. "Uncertain Demographic Futures and Social Security Finances," American Economic Review, American Economic Association, vol. 88(2), pages 237-41, May.
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