policies - including future taxes, pensions, and other government outlays - with the aim
of restoring a sustainable fiscal outlook.36
Second, it is obvious that FI and GI are static measures. Adopting FI and GI for
estimating country fiscal positions is only the first step in policy formulation within the
EMU context. Obviously, static country-specific estimates are insufficient in the context
of a monetary union among countries that are currently undergoing economic transitions
and are, by definition, in disequilibrium. Even without any policy changes - were that
possible - demographic transitions at differential rates would engender inter-EU-country
and international capital flows and labor migrations. Those flows and future policy
adjustments may invalidate the economic and demographic assumptions on which FI and
GI calculations are based. Nevertheless, the static FI and GI estimates constitute useful
information in the formulation of future policies because they indicate the extent of
pressure generated by the current fiscal stance that would induce private sector
adjustments. If maintained and allowed to grow, large fiscal and generational imbalances
may imply larger future taxes and higher interest rates and may cause larger private sector
adjustments in capital and labor flows.
FI and GI numbers presented in terms of billions (or trillions) of euros are not easily
comprehensible. To provide a reference for comparison, it is useful to calculate them as
ratios of GDP or the wage tax base out of which they would have to be financed. Since FI
and GI refer to present values of future fiscal flows, it is appropriate to use the present
values of GDP or the present value of the wage tax base when forming such ratios. These
ratios would show the additional percentage of future GDP or wages that must be devoted
to restore a balanced fiscal policy. Using alternative taxes or expenditures as a reference
base - such as total public plus private consumption, personal plus corporate income,
social transfers, etc. - would show the size of the fiscal adjustment required for achieving
a balanced policy in terms of those economic flows. Such measures would provide
broader understanding of the trade-offs involved under alternative combinations of future
fiscal adjustments.
An important characteristic of FI is that, like a corpus of outstanding debt, it grows larger
over time because of accruing interest costs: Hence, a nonzero FI represents fiscal
disequilibrium and would necessitate future policy adjustments (See Gokhale and
Smetters, 2003 for details). In addition, fiscal policies that imply FI ≠ 0 are unsustainable
because the ratio of FI to the present value of GDP (or some other income or tax base)
also grows larger over time.37
Finally, FI and GI could be decomposed according to the contributions of alternative rates
of population aging and alternative fiscal structures adopted by EU member countries.
The motivation for this lies in past experience: The SGP - focused on short- and medium-
term objectives - was revised in 2005 to take account of country-specific economic
features. The same need is likely to arise if and when the current constraints force further
consideration of longer-term structural adjustments to facilitate convergence toward a
balanced fiscal stance across EU countries. Reporting the contributions of demographics
36
37
It is implicit in this discussion that establishing a sustainable fiscal outlook is desirable because it
would boost the performance of the private sector by reducing expectations of future benefits,
thereby increasing private saving and work efforts.
This result is due to the normal condition of a dynamically efficient economy where the interest rate
exceeds the growth rate. For the U.S. context, see Abel et al. 1989. See Gokhale and Smetters
(2006) for more details.
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