Post on 29-Jun-2018
MINISTERO DELL’ECONOMIA E DELLE FINANZE
Study visit of the Delegation of the Government of Serbia
Rome, 23th January 2012
Public finance: structural deficit, sensitivity and long-term sustainability
Marco Cacciotti
MINISTERO DELL’ECONOMIA E DELLE FINANZE 2
Outline of the presentation The EU Stability and Growth pact
Theoretical underpinnings – fiscal rules
Legal requirements
Particular look at the Italian Stability and Convergence Programme:
Code of conduct
Structural deficits (derivation and results)
Sensitivity to growth (methodology and results)
Long-term sustainability of public finances (methodology and results)
Reform of the Stability and Growth Pact (ongoing) – some preliminary
elements.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 3
Theoretical underpinnings EU – Stability and Growth Pact
Need for controlling
public finances.
High and persistent
government deficits may
lead to high and
unsustainable public
debt (increasing debt
before the Euro)
Other implicit liabilities
(such as ones due to
ageing) may lead to
increases in public
debts
As of 2007, effect of the
financial crisis on public
debts due to financial
support programmes.
0
20
40
60
80
100
120
140
160
180
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
Pu
bli
c D
eb
t (%
of
GD
P)
Debt/GDP in Europe
Euro area Germany Ireland Greece Spain France Italy
Source: European Commission, 2011 Spring Forecast
MINISTERO DELL’ECONOMIA E DELLE FINANZE 4
Theoretical underpinnings EU – Stability and Growth Pact
What are the costs of unsustainable public finances in the case of a single economy?
Piling up of public debt both in recession and in expansions
High interests rates to serve public debt
No fiscal space for automatic stabilisers to operate
High inflationary pressures and reduced macroeconomic stability
Crowding out of private investments.
Source: European Commission, 2011 Spring Forecast
MINISTERO DELL’ECONOMIA E DELLE FINANZE 5
Theoretical underpinnings EU – Stability and Growth Pact
What are the negative incentives for govermments to carry out deficit spending in the case of a
monetary union ?
Spillover effects on other members state of deficit spending carried out by single
countries
Increases of interest rates spread on the whole monetary union, given the inflation target.
Higher probability of an electoral cycle in budgetary spending
Risk of jeopardizing the activity and the credibility of the Central Bank
Need to foresee mechanisms that assure fiscal policy coordinations in the Monetary Union
Fiscal rules – Stability and Growth Pact (SGP)
Macro economic stability is a pre-requirement for accessing Euro Area.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 6
Fiscal rules EU – Stability and Growth Pact
Fiscal rules are designed to impose quantitative constraints on public budgets (or part of them,
such as expenditures levels) aiming to:
permanently reduce the deficit bias and to impose a discipline on fiscal policy;
Minimize the probability of an electoral cycle of public spending
Increase the efficiency of public spending
Stabilise expectactions and the investment decisions of economic agents
Reduce the risk of pro-cyclical fiscal policies allowing the free operating of automatic
stabilisers.
Enhance the coordination of fiscal policies (weak institutional framework vis-à-vis fiscal
federalism).
MINISTERO DELL’ECONOMIA E DELLE FINANZE 7
Fiscal rules EU – Stability and Growth Pact
The provision of a fiscal rule does not always imply a better and more efficient fiscal
framework. The rule must be intertemporally credible and fully operative.
Ideally, a fiscal rule should be:
Well designed – clear juridical definition (Constitution or Law), clear specification of both ex ante and ex post
indicators, clear specification of the expenditures included (excluded) in (from) the fiscal aggregates;
Implementable: easy to apply, providing well designed procedures in cases of no compliance (either sanctions or
«escape clauses»);
Transparent: reduced possibility of «windows dressing» and reduced risk of creative accounting;
Simple: reference to numerical parameters easy to be controlloled by economic agents and financial markets;
Credible: targets should not be out of reach;
Consistent: fiscal rule should be in line with the objectives of monetary policy.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 8
The European Framework – legislative references EU – Stability and Growth Pact
The Treaty (articles 99 and 104) establishes that EU member States should avoid excessive
deficits.
Government deficit should be below 3% of GDP, unless the breaching of the reference
parametes is exceptional, temporary and limited in scope.
Public debt should not exceed 60% of GDP unless it is reducing at a satisfactory pace
approaching the reference ceiling.
Regulation of the European Council 1466/97 as modified by Regulation 1055/2005 –
preventive arm, multilateral surveillance and coordination of fiscal policies
Regulation of the European Council 1467/97 as modified by Regulation 1056/2005 –
Corrective arm - Excessive deficit procedure.
Six packs (the reform of the Stability pact just approved by the European Parliament)
Code of Conduct on Stability and Covergence programmes (to be amended to be in line with
the Six packs).
MINISTERO DELL’ECONOMIA E DELLE FINANZE 9
The old (pre-2005) Stability and Growth Pact EU – Stability and Growth Pact
The preventive arm established that all Member States should have converged over the
medium term to a government net borrowing (expressed in actual terms) close to balance or in
surplus (CTOS) which would have allowed countries to counteract turns in business cycles
without breaching the 3% of GDP deficit ceiling Link between fiscal rules and
macroeconomic stabilisation
Member States could have presented government deficit higher than 3% of GDP if the output
had fallen by a rate higher (or equal to) 2% in real terms and if the breaching was temporary
and limited. If GDP decreases between 0.75% and 2%, Council should have decided whether
the macroeconomic conditions had to be considered exceptional or not. In the former case,
deficit could have been temporarily higher that 3% of GDP for a limited period.
The corrective arm established that, in case budget constraints were not met, Member States
could have been subject to sanctions (deposit equal to 0.5% of GDP) or fines.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 10
The 2005 version of the Stability and Growth Pact EU – Stability and Growth Pact
In 2002 Germany and France breached the deficit criterion. debate on more flexibility of SGP rules In march
2005 the European Council approved a reform of the SGP more rules and exemptions
Preventive arm
New parameters in the deficit criterion structural deficit (cyclically adjusted deficit net of one offs measures).
New rules country specific Medium term objectives (MTO), i.e. structural deficits linked to countries’ level of
initial debt and implicit liabilities (ageing expenditures). More flexibility for countries with low debt, reduced cost
of ageing and high potential
New rules member states far away from the MTOs should converge towards them by reducing the structural
deficit by at least 0.5 pp of GDP every years.
Assessement of one-off measures to counteract «windows dressing» and creative accounting.
Corrective arm
Less rigid definition of «severe economic crisis» based on potential output loss or reduced potential growth,
assessment of structural (pension reforms) and specific circumstances possibility to breach 3% of deficit/GDP
ratio.
Link to structural reforms and Lisbon Strategy.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 11
The current version of the Stability and Growth Pact – the
European Semester.
EU – Stability and Growth Pact
In 20010 introduction of the European Semester
The " European Semester " means the EU and the euro zone coordinate ex ante their budgetary
and economic policies, in line with both the Stability and Growth Pact and the Europe 2020
strategy.
The EU Semester starts with the Annual Growth Survey, in which the Commission provides a
solid analysis on the basis of the progress on Europe 2020 targets, and sets out an integrated
approach to recovery and growth, concentrating on key measures. This applies to the EU as a
whole and will then be translated into country-specific recommendations.
This procedure applies to the EU as a whole and is translated into country-specific
recommendations, thus allowing the ex ante economic coordination at EU level while national
budgets are still under preparation.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 12
The current version of the Stability and Growth Pact – the
European Semester.
EU – Stability and Growth Pact
MINISTERO DELL’ECONOMIA E DELLE FINANZE 13
Requirements of the Code of Conduct Stability Programme
In the context of the European Semester, Member States every year submit to Commission
and Council the Stability and Convergence programmes.
Stability (Euro Area Countries) and Convergence programs (non Euro Area Countries) are
public documents submitted to Commission and Council, every year together with the National
Reform Programs, by mid-April. Commission and Council have to assess them and adopt
opinions and policy recommendations by end of July.
The Stability Program should follow the guidelines of the Annual Growth Survey and contain
the following info:
a) Actual and structural government balances and public debt planned for the medium
term (from t-1 to t+4);
b) Medium Term Objectives for budget (in structural terms);
c) the main underlying macroeconomic assumptions;
d) a description of the main budgetary measure to achieve the objectives and quality of
public finance.
e) sensitivity analysis on GDP growth assumptions and interest rates.
f) Long term sustainability of public finances.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 14
Structural deficit
Why structural deficit?
General Government balance (in % of GDP) expressed in nominal terms is
subject to transitory (mainly cyclical) and permanent (istitutional) factors.
In order to use the fiscal levy in a counterciclycal fashion, policy-makers
should be able to disentagle business cycle influences on the budget.
Using goverment targets expressed in nominal terms may entail the risk that
that stabilization policies may turn out as being procyclical.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 15
Estimation of the structural balance (SB) Structural deficit
The structural balance is defined as the general government balance, adjusted
for the cycle (CAB) and without one-off and other temporary measures.
[1]
The CAB (% GDP) is derived by subtracting from the headline general
government balance as a ratio to GDP(b) its cyclical component:
[2]
The budgetary sensitivity ε is the change in the general government balance
as a percent of GDP associated with an additional percentage point of output
gap. For Italy ε = 0.5.
The cyclical component is given by the product of ε and the Output Gap (OG).
Look at OG, ε and one-off measures.
ttt oneoffsCABSB
ttt OGbCAB
MINISTERO DELL’ECONOMIA E DELLE FINANZE 16
Estimation of Output gaps Structural deficit
The OG is the discrepancy between the level of current real GDP and its
potential (in percentual of this one). To estimate potential output, a production
function approach (commonly agreed at EU level) is adopted.
[3]
GDP is represented as a Cobb-Douglas-type production function with constant
returns to scale on capital (K) and labour (L)
TFP is the total factor productivity, i.e. the contribution of technical progress to
economic growth.
α is the output elasticity with respect to labour. Given constant returns to scale
and perfect competition, is coincident to the wage share.
Potential output is obtained by replacing in [3], an estimate of K, L and TFP
corresponding to their full or potential utilisation.
tttt TFPKLY
1
MINISTERO DELL’ECONOMIA E DELLE FINANZE 17
Estimation of Output gaps – Labour contribution to potential Structural deficit
The estimate of potential labour (LP) is achieved by smoothing a set of
exogenous variables over the historical sample and over a medium-term
extension period (usually 6y = a short-term forecast horizon + 3 year of
technical extrapolation so as to minimize the end-point-bias).
[4]
PARTS is the trend component of the unadjusted participation rate obtained by
Hodrick-Prescott (HP) filter.
POPW is the working-age population, extrapolated out of the sample period
using the Eurostat 2010 long range population projections.
HOURST is the trend of average hours worked per employee and it is
smoothed using an ARIMA process.
NAWRU is the non-accelerating wage rate of unemployment.
)1(*** ttttt NAWRUHOURSTPOPWPARTSLP
MINISTERO DELL’ECONOMIA E DELLE FINANZE 18
Estimation of Output gaps – NAWRU specification Structural deficit
NAWRU is derived by applying an unobserved component model estimated by
a Kalman filter.
The observed unemployment series is decomposed into a trend and a cyclical
component.
The trend component is modelled as a random walk with drift (the drift term
itself follows a random walk). The cyclical component is obtained via a Phillips
curve which regresses the change in wage inflation on cyclical unemployment
as well as on other exogenous variables (labour productivity, terms of trade
and wage share). In the out of sample extrapolation, the NAWRU is extended
over the forecast period by a mechanical rule which allows stabilising it after a
period of 3 years.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 19
Estimation of Output gaps – Capital contribution to potential Structural deficit
Potential capital stock, measured by the perpetual inventory method,
corresponds to its actual value
The full utilisation of the existing stock is assumed.
The capital is extrapolated in the out-of-sample period according to a given
profile of productive investment (estimated through an AR(2) process) and
assuming a constant depreciation rate.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 20
Estimation of Output gaps – TFP specification
Technical progress (TFP) is assumed to be propagated in a neutral way through qualitative
improvements both in labour and capital inputs.
TFP sums up both the level of efficiency of labour and capital inputs and their degree of
utilisation.
Structural deficit
))(( 11 KLKLt UUEETFP
MINISTERO DELL’ECONOMIA E DELLE FINANZE 21
Estimation of Output gaps – TFP contribution to potential Structural deficit
The long-run component of TFP is obtained through a a bivariate Kalman Filter (KF)
model which exploits the link between the TFP cycle and the degree of capacity
utilisation in the economy.
Its basic structure is similar to the Phillips-curve augmented unobserved component
model proposed by Kuttner (1994) for estimating potential output and output gaps in
the US.
Capacity utilization is measured using two indicators: the Capacity Utilization Indicator
(CUI), which is available for manufacturing only, and the Business Survey Capacity
Indicator (BS) collected for manufacturing, construction and services as part of the
European Commission's Business and Consumer Survey Programme.
TFP can be obtained by applying either a Maximum Likelihood or Bayesian (default
model) estimation techniques to the bivariate model in state-space specification given
by the Solow Residual (SR) (derived by replacing in equation [3] the observed value
of GDP, employment, hours worked and capital stock) and the series of Capacity
utilisation.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 22
Estimation of Output gaps – Capital and TFP contribution to potential Structural deficit
Once potential labour, capital stock and long-run TFP are derived, the level of
potential output is obtained by substitution in eq. [3]
The determination of potential output allows deriving the value of the output
gap (measures as the discrepancy between the actual level of GDP and its
potential in percent of this one)
[5]
*1
ttt
pot
t TFPKLPY
1001
Pot
t
tt
Y
YOG
MINISTERO DELL’ECONOMIA E DELLE FINANZE 23
Estimation of the structural balance (SB) (II) – budget sensitivities Structural deficit
The budgetary sensitivity ε is obtained by aggregating the OECD elasticity (η) of single
budgetary items considered as highly dependant on cyclical developments with
respect to their relative budgetary weight on the total revenue (R) or expenditure (G).
On the revenue side we consider: personal income tax, social contributions, corporate
income tax and indirect taxes. On the expenditure side: unemployment transfers.
The revenue and expenditure elasticities are transformed into sensitivity parameters
by expressing them as a ratio of GDP:
So the sensitivity parameter ε is:
G
G
R
R U
UGG
i
i
iRR ,
4
1
, ,
Y
G
Y
RGGRR ,
GR
MINISTERO DELL’ECONOMIA E DELLE FINANZE 24
Estimation of the structural balance (SB) (III) – one-offs measures Structural deficit
One-offs are measures with a transitory budgetary effect that does not lead to a
sustained change in the intertemporal budgetary position
not exhaustive list: tax amnesties implying a one-off tax payment (to repatriate capital
from abroad); Sales of non-financial assets, typically real-estate, licences and
concessions; Legislative changes (permanent or temporary) with a temporary effect in
the timing of outlays or revenues; exceptional revenue linked to the transfer of pension
obligations; Exceptional revenue from state-owned companies; changes in revenue or
expenditure consecutive to Court or other authorities rulings; short-term emergency
costs associated with major natural catastrophes or other exceptional events;
Securitisation operations.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 25
Estimation of the structural balance (SB) – Results for Italy – DEF – Stability
Programme (April 2011)
Structural deficit
In April 2011, structural deficit was expected to fall by 0,5 p.p. in the current year and by 0.8 p.p. the next,
getting to -2,2% of GDP at the end of 2012, in line with the commitments agreed at a European level .
In 2013 and 2014, as a result of additional fiscal measures announced by the government (amounting,
cumulatively to 2.3 percentage points of GDP) cyclically adjusted budget balance, net of one-off measures,
should have continued to fall by 0.8 p.p. per year.
Italy was expected to reach the Medium Term Objective (MTO) by 2014.
2009 2010 2011 2012 2013 2014
GDP growth rate at constant prices -5,2 1,3 1,1 1,3 1,5 1,6
Net borrowing -5,4 -4,6 -3,9 -2,7 -1,5 -0,2
Interest payments 4,6 4,5 4,8 5,1 5,4 5,5
Potential GDP growth rate -0,1 0,1 0,3 0,4 0,6 0,8
Contribution of productive factors to potential growth
Labour 0,0 0,1 0,1 0,1 0,2 0,2
Capital 0,2 0,2 0,3 0,3 0,3 0,4
Total factor productivity -0,4 -0,2 -0,1 0,0 0,1 0,2
Output gap -3,9 -2,7 -1,9 -1,1 -0,3 0,5
Cyclical budgetary component -1,9 -1,3 -1,0 -0,6 -0,1 0,3
Cyclically-adjusted budget balance -3,5 -3,3 -2,9 -2,2 -1,3 -0,5
Cyclically-adjusted primary surplus 1,2 1,3 1,9 2,9 4,0 5,0
One-off measures 0,7 0,2 0,1 0,1 0,0 0,0
Budget balance, net of one-off measures -6,0 -4,8 -4,0 -2,8 -1,5 -0,3
Cyclically-adjusted budget balance, net of one-off measures -4,1 -3,5 -3,0 -2,2 -1,4 -0,5
Cyclically-adjusted primary surplus, net of one-off measures 0,5 1,1 1,8 2,9 4,0 4,9
Change in budget balance, net of one-off measures 3,1 -1,2 -0,8 -1,2 -1,3 -1,2
Change in cyclically-adjusted budget balance, net of one-off measures 0,5 -0,6 -0,5 -0,8 -0,8 -0,8
MINISTERO DELL’ECONOMIA E DELLE FINANZE
In spite of the the resurfacing of tensions in financial markets, the downward revision in real and potential output growth,
the Government adopted a series of fiscal measures that increased the cumulative fiscal adjustment planned last April.
Overall, the fiscal package approved by Parliament in September amounts to €59,8 billion, the equivalent of around
3.4% of GDP.
The budget will be balanced already in 2013. The MTO is then expected to be reached one year in advance than
previously planned.
26
2009 2010 2011 2012 2013 2014
Real GDP growth -5,2 1,3 0,7 0,6 0,9 1,2
Net borrowing -5,4 -4,6 -3,9 -1,6 -0,1 0,2
Interest expenditure 4,6 4,5 4,8 5,3 5,5 5,5
Potential GDP growth rate 0,0 0,1 0,2 0,1 0,3 0,5
Contribution of productive factors to potential growth
Labour 0,0 0,0 0,1 0,0 0,1 0,1
Capital 0,2 0,2 0,3 0,3 0,3 0,3
Total factor productivity -0,1 -0,1 -0,1 -0,1 -0,1 0,0
Output gap -4,1 -3,0 -2,5 -2,1 -1,5 -0,8
Cyclical budgetary component -2,1 -1,5 -1,3 -1,0 -0,8 -0,4
Cyclically-adjusted budget balance -3,3 -3,1 -2,6 -0,5 0,7 0,6
Cyclically-adjusted primary surplus 1,3 1,4 2,2 4,8 6,1 6,1
One-off measures 0,7 0,2 0,2 0,0 0,0 0,1
Budget balance, net of one-off measures -6,0 -4,8 -4,1 -1,6 -0,1 0,1
Cyclically - adjusted budget balance, net of one off measures -4,0 -3,3 -2,8 -0,6 0,6 0,5
Cyclically adjusted primary surplus, net of one off measures 0,7 1,2 2,0 4,7 6,1 6,0
Change in budget balance,net of one off measures 3,1 -1,2 -0,7 -2,5 -1,5 -0,3
Change in cyclically -adjusted budget balance, net of one-off measures 0,4 -0,7 -0,5 -2,3 -1,2 0,1
Structural deficit
Estimation of the structural balance (SB) – Results for Italy – Update of DEF (September 2011)
MINISTERO DELL’ECONOMIA E DELLE FINANZE 27
Sensitivity analysis – net borrowing and debt in alternative scenarios
The sensitivity analysis measures the impact of alternative growth scenarios (higher
or lower GDP growth of +/- 0.5 p.p per year) on actual and structural government
balances and public debt.
In the alternative scenario, the primary balance is given by the sum of the cyclically
adjusted primary balance and the cyclical component. The latter is the product of the
elasticity to growth (0.5 for Italy) with the output gap of alternative scenario.
The cyclically adjusted primary balance is given by the difference between the
cyclically-adjusted revenue and expenditures derived as deviation from the baseline
relations:
Public debt in the alternative scenario is calculated assuming: the same implicit
interest rate and stock flow adjustment as the baseline and substituting the primary
balance and the nominal GDP of the alternative scenarios .
Budget sensitivity to changes in GDP growth
𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝐴𝑐𝑎 =
𝑅𝑐𝑎
𝑌𝐵 ∗
𝑌𝐵
𝑌 𝐴 ∗ 1 + 𝜀𝑅 ∗
𝑌 𝐴 − 𝑌 𝐵
𝑌 𝐵 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝐴
𝑐𝑎 = 𝐸𝑐𝑎
𝑌𝐵 ∗
𝑌𝐵
𝑌 𝐴 ∗ 1 + 𝜀𝐸 ∗
𝑌 𝐴 − 𝑌 𝐵
𝑌 𝐵
MINISTERO DELL’ECONOMIA E DELLE FINANZE 28
Sensitivity analysis – net borrowing/GDP in alternative scenarios –
DEF – Stability Programme (May 2011)
Budget sensitivity to changes in GDP growth
-6,0
-5,0
-4,0
-3,0
-2,0
-1,0
0,0
1,0
2011 2012 2013 2014
High-growth scenario Baseline scenario Low-growth scenario
MINISTERO DELL’ECONOMIA E DELLE FINANZE 29
Sensitivity analysis debt/GDP in alternative scenarios
DEF – Stability Programme (May 2011)
Budget sensitivity to changes in GDP growth
105,0
110,0
115,0
120,0
125,0
2011 2012 2013 2014
High-growth scenario Baseline scenario Low-growth scenario
MINISTERO DELL’ECONOMIA E DELLE FINANZE 30
Sustainability of Public finances- Public debt projections
Long term sustainability of public finances presents both the evolution of the
debt/GDP ratio up till 2060 as a function of age-related expenditure projections and
sustainability indicators (S1 and S2).
Age-related expenditures are: pensions (projected through national models), healt-
care and long term care outlays, education expenditures and unemployment benefits
(projected by the European Commission on the basis of commonly agreed models
and assumptions).
The underlying macroeconomic and demographic assumptions and age-related
expenditures are agreed at EU level (Ageing Working Group – 2009 Ageing Report).
Tax revenue are kept constant at the level (in term of GDP) resulting from the last year
of the Stability Programme (2014). Structural primary balance and debt change
according to the evolution of age related expenditures.
[6]
Long term debt dynamics
01 1 t t t t t t td d r d pb pi are
MINISTERO DELL’ECONOMIA E DELLE FINANZE 31
Long-term projections of revenues and expenditure (may 2010)
LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
In order to take the effects of the crisis into account, the underlying macroeconomic outlook assumes the “lost decade
scenario” in which labour productivity converges to the AWG baseline scenario by 2020.
Total expenditures are projected to increase in 2010 as an effect of the crisis and then decrease up till the level of
45.0% of GDP in 2060. Pension expenditure are expected to increase in the medium term and then decrease. As a
result of the crisis, healthcare expenditure will be on a higher level than compared to last year projections but its
dynamic would not change.
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060
Total expenditure 48,2 50,6 48,1 47,0 46,2 46,1 46,2 46,7 47,0 46,4 45,8 45,0
of which: age-related expenditure 26,1 28,6 27,9 27,5 27,4 27,9 28,3 29,0 29,3 28,9 28,6 28,2
Pension expenditure 14,0 15,3 15,4 15,1 14,9 15,2 15,4 15,7 15,6 14,9 14,3 13,9
of which: seniority and old-age pensions 13,4 14,8 14,9 14,6 14,5 14,8 15,0 15,4 15,3 14,6 14,0 13,6
of which: other pensions (disability and survivors) 0,6 0,5 0,5 0,5 0,5 0,4 0,4 0,3 0,3 0,3 0,3 0,3
Healthcare expenditure 6,7 7,3 7,3 7,4 7,6 7,9 8,1 8,4 8,6 8,7 8,8 8,8
Long-term care expenditure 0,8 1,0 1,0 1,0 1,1 1,1 1,2 1,3 1,4 1,5 1,6 1,7
Education expenditure 4,2 4,2 3,7 3,5 3,4 3,2 3,2 3,2 3,3 3,3 3,4 3,4
Unemployment benefits 0,4 0,7 0,5 0,4 0,4 0,4 0,4 0,4 0,4 0,4 0,4 0,4
Interest expenditure 4,5 4,9 5,2 4,5 3,8 3,3 2,9 2,7 2,6 2,5 2,2 1,8
Total revenues 43,8 46,0 45,9 45,8 45,8 45,8 45,8 45,8 45,8 45,7 45,7 45,7
of which: property income 0,6 0,6 0,6 0,6 0,6 0,5 0,5 0,5 0,5 0,5 0,5 0,5
% GDP
MINISTERO DELL’ECONOMIA E DELLE FINANZE 32
Long-term projections of pension expenditures/GDP LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
Pension expenditures are almost 15% of GDP but they are projected to keep relatively stable until 2045 in spite of the
retirement of the “baby boom” generation.
The recent pension reforms approved in the summer (among which the anticipation to 2013 of the mechanism linking
the statutory retirement age to life expectancy, the increase of the retirement age of women to 65 and the
strengthening of the exit windows) will reduce expenditure up to 0.6 pp of GDP in 2030 and 0.3pp of GDP until 2045.
MINISTERO DELL’ECONOMIA E DELLE FINANZE 33
Debt to GDP projections under alternative assumptions
DEF – Stability Programme (May 2011)
LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
The fiscal targets planned by the government in May will bring the debt/GDP ratio over a descending path over
the long term.
The adoption of labour market reforms spurring productivity will automatically improve the sustainability of public
finances over the long term. In case of negative shocks in labour productivity, the sustainability is not at risk.
-60
-30
0
30
60
90
120
201
4
201
6
201
8
202
0
202
2
202
4
202
6
202
8
203
0
203
2
203
4
203
6
203
8
204
0
204
2
204
4
204
6
204
8
205
0
205
2
205
4
205
6
205
8
206
0
baseline
productivity +0.2 p.p. from 2015
productivity -0.2 p.p. from 2015
female activity rate +5% in 2060
MINISTERO DELL’ECONOMIA E DELLE FINANZE 34
Sustainability indicators: S1 and S2 LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
S2 measures the structural primary balance permanent adjustment that would allow to
fullfil the intertemporal budget constraint over an infinite horizon.
[7]
S2 can be decomposed in two sub-indicators:
D (initial budgetary position) it quantifies the permanent adjustment in the structural
primary balance which is needed to keep the debt/GDP ratio constant at its initial
value (dt0) by offsetting the snowball effect (the built up of interest expenditures). The
technical assumption is that there are no age-related changes in the primary balance
(Δpbs=0).
E (long-term changes in the primary balance) measures the permanent adjustment in
the structural primary balance that it is needed to offset the cost of ageing (implicit
liabilities).
0 0
0 1--------------------- ------------------------------------
2 1t t s s
s t
D E
S rd pb w pb
0
0
0 1
1
1
s t
ss t
s t
rw
r
MINISTERO DELL’ECONOMIA E DELLE FINANZE
35
Sustainability indicators: S1 and S2
LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
S1 measures the structural primary balance permanent adjustment that would allow the
debt/GDP ratio to converge to 60% ceiling by 2060.
[8]
S1 can be decomposed in three sub-indicators:
A (initial budgetary position) and C (long-term changes in the primary balance) are
similar to the sub-components of S2.
B (debt requirement in 2060) measures the additional structural primary balance
adjustment that is needed to bring the intial debt/GDP ratio (dt0) at the level of 60%
in 2060 by assuming no change in the age related expenditures.
0
0 0 0
0
*2060
2060
20601
--------------------- ------------------------------------------------------------------------
1 11 1
t
t t s sts t
A B
r d dS rd pb z pb
r
C
0
0
0
2060
1
1
1
s t
ss t
s t
rz
r
MINISTERO DELL’ECONOMIA E DELLE FINANZE 36
Sustainability indicators: S1 and S2 – results for Italy
DEF – Stability Programme (May 2011)
LONG-TERM SUSTAINABILITY OF PUBLIC FINANCES
Long term sustainability is not an issue for Italy. The fiscal adjustment
planned in the Stability programme (with a structural primary balance of 4.9
per cent of GDP in 2014) would allow to offset the increase in the cost of
ageing.
The Required Primary Balance (RPB), i.e. the primary balance that satisfies
the S2 conditions in the medium-term, is lower than the structural primary
balance resulting in 2014.
S1 S2 RPB
Value -2.2 -3.0 2.1
of which:
Initial budgetary position -3.3 -3.3 -
Debt requirement in 2060 0.8 - -
Long-term changes in the primary balance 0.3 0.3 -
MINISTERO DELL’ECONOMIA E DELLE FINANZE
The Medium term budgetary objective (MTO)
MTO is a country-specific indicator defined in cyclically adjusted terms, net of one-off and
other temporary measures.
MTOs derivation must take into account of three components:
The debt-stabilising balance for a debt ratio equal to the (60% of GDP) reference value
(dependent on long-term potential growth), implying room for budgetary manoeuvre for
member States with relatively low debt;
A supplementary debt reduction for Member State with a debt ratio (60% of GDP) in
excess of the reference value, implying rapid progress towards it;
A fraction of the adjustment needed to cover the present value of the future increase in
age-related government expenditure.
37
THE IMPLEMENTATION OF THE STABILITY AND GROWTH PACT
MINISTERO DELL’ECONOMIA E DELLE FINANZE
The Medium term budgetary objective (MTO) MTO is given by:
The components MTOMB and MTOEuro/ERM2 refer, respectively, to the mininimum benchmark and to a
strutural deficit not lower than 1% of GDP, while the component MTOILD relates to implicit and explicit liabilities
where:
the first term on the right-side is the budgetary balance that would stabilise the debt ratio at 60% of GDP;
the second term, corresponding to the budgetary component of the S2 indicator, is the budgetary
adjustement that would cover a fraction of the present value of the increase in the age related expenditure
The third term rappresents a supplementary debt –reduction effort , specific to countries with gross debt
above 60% of GDP. The supplementary debt effort takes the form of a linear function.
38
)()(
)(
)%60(
*33.0
iii
reductiondebt
ii
i
ofGDPgstabilizindebt
ILD
EffortsAgeingCost
BalanceMTO
THE IMPLEMENTATION OF THE STABILITY AND GROWTH PACT
),,max( 2/ ERMEuroMBILD MTOMTOMTOMTO
MINISTERO DELL’ECONOMIA E DELLE FINANZE
Adjustment path toward the Medium-term budgetary objective (MTO)
Member States far away from the MTO should converge towards it by reducing the
structural deficit by 0.5 pp per year. After the crisis, this mechanism has been reinforced.
The presumption is to use the unexpected extra revenues windfalls for deficit and debt
reduction while keeping expenditure on a stable sustainable path over the cycle.
The Commission and the Council will assess the growth path of government expenditure
against a reference medium term rate of potential GDP growth.
For countries far away from the their MTO, public expenditures can grow at a rate well
below the reference medium-term rate of potential GDP (unless covered by increases in
discretionary revenues) so that the structural deficit falls by at least 0.5pp every years.
Member States at the MTO can leave expenditure grow at the same rate of the reference
potential GDP.
The reference medium-term rate of potential GDP growth is based on both forward-
looking and backward-looking estimates (t-5, t+5).
39
THE REFORM OF THE STABILITY AND GROWTH PACT
MINISTERO DELL’ECONOMIA E DELLE FINANZE
The Excessive deficit procedure – The debt rule
In addition to deficit, the Commission has to examine compliance with budgetary discipline on the
basis of debt criteria (reference to 60% of Debt/GDP).
Accordingly, the Commission will always prepare a report for Excessive Deficit Procedure a report
when at least one of the conditions (1) or (2) holds:
A planned government deficit exceeds the reference value of 3% of GDP
A reported government debt ratio is above the reference value of 60% of GDP and its differential w.r.t. the
reference value has not decreased over the past three years at a rate of one-twentieth as a benchmark, which is
measured by an excess of the debt ratio reported for the year t over a backward looking element of a benchmark
(but also some forward-looking elements will be taken into account).
40
THE REFORM OF THE STABILITY AND GROWTH PACT