a CGE-OLG model). We present an assessment of the sustainability of current
policies and show that there is a substantial sustainability problem despite the
fact that Denmark currently has a budget surplus. Since there is an underlying
trend deteriorating public finances, this case brings forth the weaknesses and
strengths of both indicators. We also present assessment of the implications of
three types of reforms (retirement, tax and labour market reform) and discuss
aspects to be taken into account in designing reforms.
The paper is organized as follows: Section 2 presents a short overview of
different approaches to assess the sustainability of fiscal policies. The approach
taken in this paper is presented in section 3, and section 4 provides information
on the analysis performed for Denmark. The results on fiscal sustainability are
presented in section 5. Section 6 discusses reform strategies and presents an
evaluation of reform proposals, and section 7 provides a few concluding remarks.
2 Approaches in assessing fiscal sustainability
The concept of fiscal sustainability can be defined in different ways, but the
most widespread interpretation is "the government’s ability to indefinitely main-
tain the same set of policies while remaining solvent" (Burnside (2004, ch. 2
p1).Various approaches and methods have been proposed in the literature to as-
sess the sustainability of fiscal policy. They all depart from the identify linking
changes in public debt to the primary balance and debt servicing (all measured
relative to gdp),
dt+1 =(1+rt)dt - bt (1)
where r is the interest rate (growth corrected rate of return), d denotes debt
and b the budget balance (revenues less expenditures) relative to GDP.
Steady state conditions
For given interest rates, growth rates etc. this identity provides a relationship
between the debt level (d*) and the primary balance (b*) which can be sustained
in the long run (steady state). From this, one can from a targeted debt level
infer a required level for the primary balance, or vice versa from a given primary
balance infer the implied debt level (provided stability). This approach leads to
the so-called primary gap indicator (see e.g. Blanchard(1990)) which gives the
difference between the current primary balance and the level needed to sustain
a given debt level. The fiscal norms of the GSP pact can also be interpreted
from this perspective since a debt level of 60% of GDP can be maintained by a
primary deficit of 3% of GDP provided that the growth corrected real rate of
return is 5%.
Debt dynamics:
It is well-known that the stability properties of the debt level depends on
the real rate of interest being less than the growth rate. Endogenizing interest
determination allows for the possibility that the stability condition depends on
the debt level. This implies that there may be threshold levels for public debt
below which the system remains stable. Identifying the threshold and comparing