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Comments on the Economic
Policy Council’s 2019 Report
Lars Calmfors
Helsinki
29 January 2020
Outline
1. The Finnish Economic Council
2. Finland’s economic-policy problems in a Nordic perspective
3. Fiscal policy in a medium-term perspective
4. The relationship between employment and fiscal targets
5. The council’s analysis of long-run fiscal sustainability
Economic Policy Council in Finland
• Broad remit – not only fiscal policy
• High standards
- independence
- qualification requirements
- appointment procedures
• But insufficient resources: perhaps pool resources of EPC and NAOF
• Reports of high quality
• Valuable input into the economic-policy discussion
• But uneven level of abstraction in reports
- some parts are not so accessible to a wider audience
- advice: separate better between parts for a wider audience and parts for specialists
General government fiscal balance, percent of GDP
-12
-10
-8
-6
-4
-2
0
2
4
6
8
19901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015201620172018
Denmark
Finland
Sweden
Maastricht debt, percent of GDP
0
10
20
30
40
50
60
70
80
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Denmark
Finland
Sweden
General government net financial wealth, percent of GDP
-60
-40
-20
0
20
40
60
80
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Denmark
Finland
Finland, before revision
Sweden
S2 sustainability indicator
Denmark -1 – -2
Finland 3 – 5
Sweden -1 – 1
0
10
20
30
40
50
60
70
2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075 2080 2085 2090 2095 2100
Figure 3b: Elderly dependency ratio, 2015 to 2100
(65 and older as share of 15 to 64)
Iceland Norway Sweden Finland Denmark
Fiscal targets and forecasts
Targets
• Medium-term objective (MTO):
Maximum structural deficit of
0.5% of GDP
• Government target: zero
(nominal) fiscal balance in 2023
Forecasts
• Structural deficit of 1.3% of GDP
in 2023
• Nominal fiscal deficit of 1.2% of
GDP in 2023
• Expenditure on fighter jets not
included
Discrepancy between forecasts and targets
• Government expenditure increases
• The goverment hopes to cover the discrepancy through higher
revenues (and lower expenditure) from employment increases
• The council is concerned that EU rules will be violated
• Wrong timing from a stabilisation policy point of view
Negative interest-growth differential
• Debt can ”pay for itself”
• Debt-to-GDP ratio can fall also
with primary deficits (if not too
large)
• Argument has some merit in
Denmark and Sweden with low
debt ratios
• Dangerous argument for Finland
• Bond yields rise with debt above
threshold
• Risk of snowball effect
• Fiscal fatigue threshold?
Other aspects of fiscal policy
• Expenditure increases are financed by sales of financial assets
- Financial-asset sales and government borrowing affect net financial
wealth in identical ways
• The future-oriented investment programme
- All is not investment
• Escape clause for spending limit (expenditure ceiling)
- exceptional situation
The government’s labour-market
targets
• Target for employment rate of 75% in 2023
• Target for unemployment rate of 4.8% in 2023
• Key element in the government’s plan to meet the
fiscal targets
Fiscal impact of higher employment according
to the council
• Back-of-envelope calculation: 1 percentage point higher employment
rate improves primary balance by 0.8% of GDP
• Microsimulation: 1 percentage point higher employment rate
improves primary balance by 0.4% of GDP
• Sustainability-gap calculation: 1 percentage point higher employment
rate improves sustainability indicator by 0.4% of GDP
Problems with calculations
•Increase in employment is not an exogenous
event
•Instead, it is an endogenous response to policy
Differential fiscal effects depending on
employment policy
• Less generous benefits
- lower unemployment benefits
- more restricted access to unemployment benefits
- more restricted access to early retirement
- higher retirement age
• Earned income tax credit
- Sweden: only 20-30% of static revenue loss offset by dynamic gains
• Employment subsidy
- uncertainty regarding crowding-out effects on non-subsidised employ-
ment
Fiscal policy and employment policy
• Expenditure increases are conditioned on employment policy
- conditioning on ex-ante assessment of effects according to council
• Problems with assessment
- definition of employment-policy measure
- does employment change depend on these measures or on
something else?
- fiscal impact of employment measure?
• Unnecessary complications
- all that is required is comparisons of good fiscal forecasts with fiscal
targets
Fertility and the sustainability indicator
• Alternative scenario with fertility rate of 1.2 instead of 1.45
• Small effect (0.3% of GDP) with time horizon till 2070
Fertility and the sustainability indicator
• Alternative scenario with fertility rate of 1.2 instead of 1.45
• Small effect (0.3% of GDP) with time horizon till 2070
• Impact is doubled (to 0.6% of GDP) if time horizon is lengthened to
2085
- full account of effect of smaller labour force
• But time horizon should be lengthened even longer
- to take into account that number of pensioners ultimately fall, too
• Likely zero effect in the very long run
• Cf analysis for Norway by Statistics Norway
Main conclusions
1. High-quality work by the Economic Policy Council
- but analysis of link between employment policy and fiscal policy
could be sharpened
2. Finland has a large fiscal sustainability problem
- current policy does not appear well designed to address this
problem
Caveat: This is an outsider’s view
But: Hard for an outsider to come to any other conclusion

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Comments by Professor Lars Calmfors: Economic Policy Council's 2019 Report

  • 1. Comments on the Economic Policy Council’s 2019 Report Lars Calmfors Helsinki 29 January 2020
  • 2. Outline 1. The Finnish Economic Council 2. Finland’s economic-policy problems in a Nordic perspective 3. Fiscal policy in a medium-term perspective 4. The relationship between employment and fiscal targets 5. The council’s analysis of long-run fiscal sustainability
  • 3. Economic Policy Council in Finland • Broad remit – not only fiscal policy • High standards - independence - qualification requirements - appointment procedures • But insufficient resources: perhaps pool resources of EPC and NAOF • Reports of high quality • Valuable input into the economic-policy discussion • But uneven level of abstraction in reports - some parts are not so accessible to a wider audience - advice: separate better between parts for a wider audience and parts for specialists
  • 4. General government fiscal balance, percent of GDP -12 -10 -8 -6 -4 -2 0 2 4 6 8 19901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015201620172018 Denmark Finland Sweden
  • 5. Maastricht debt, percent of GDP 0 10 20 30 40 50 60 70 80 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Denmark Finland Sweden
  • 6. General government net financial wealth, percent of GDP -60 -40 -20 0 20 40 60 80 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Denmark Finland Finland, before revision Sweden
  • 7. S2 sustainability indicator Denmark -1 – -2 Finland 3 – 5 Sweden -1 – 1
  • 8. 0 10 20 30 40 50 60 70 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075 2080 2085 2090 2095 2100 Figure 3b: Elderly dependency ratio, 2015 to 2100 (65 and older as share of 15 to 64) Iceland Norway Sweden Finland Denmark
  • 9. Fiscal targets and forecasts Targets • Medium-term objective (MTO): Maximum structural deficit of 0.5% of GDP • Government target: zero (nominal) fiscal balance in 2023 Forecasts • Structural deficit of 1.3% of GDP in 2023 • Nominal fiscal deficit of 1.2% of GDP in 2023 • Expenditure on fighter jets not included
  • 10. Discrepancy between forecasts and targets • Government expenditure increases • The goverment hopes to cover the discrepancy through higher revenues (and lower expenditure) from employment increases • The council is concerned that EU rules will be violated • Wrong timing from a stabilisation policy point of view
  • 11.
  • 12. Negative interest-growth differential • Debt can ”pay for itself” • Debt-to-GDP ratio can fall also with primary deficits (if not too large) • Argument has some merit in Denmark and Sweden with low debt ratios • Dangerous argument for Finland • Bond yields rise with debt above threshold • Risk of snowball effect • Fiscal fatigue threshold?
  • 13. Other aspects of fiscal policy • Expenditure increases are financed by sales of financial assets - Financial-asset sales and government borrowing affect net financial wealth in identical ways • The future-oriented investment programme - All is not investment • Escape clause for spending limit (expenditure ceiling) - exceptional situation
  • 14. The government’s labour-market targets • Target for employment rate of 75% in 2023 • Target for unemployment rate of 4.8% in 2023 • Key element in the government’s plan to meet the fiscal targets
  • 15. Fiscal impact of higher employment according to the council • Back-of-envelope calculation: 1 percentage point higher employment rate improves primary balance by 0.8% of GDP • Microsimulation: 1 percentage point higher employment rate improves primary balance by 0.4% of GDP • Sustainability-gap calculation: 1 percentage point higher employment rate improves sustainability indicator by 0.4% of GDP
  • 16. Problems with calculations •Increase in employment is not an exogenous event •Instead, it is an endogenous response to policy
  • 17. Differential fiscal effects depending on employment policy • Less generous benefits - lower unemployment benefits - more restricted access to unemployment benefits - more restricted access to early retirement - higher retirement age • Earned income tax credit - Sweden: only 20-30% of static revenue loss offset by dynamic gains • Employment subsidy - uncertainty regarding crowding-out effects on non-subsidised employ- ment
  • 18. Fiscal policy and employment policy • Expenditure increases are conditioned on employment policy - conditioning on ex-ante assessment of effects according to council • Problems with assessment - definition of employment-policy measure - does employment change depend on these measures or on something else? - fiscal impact of employment measure? • Unnecessary complications - all that is required is comparisons of good fiscal forecasts with fiscal targets
  • 19. Fertility and the sustainability indicator • Alternative scenario with fertility rate of 1.2 instead of 1.45 • Small effect (0.3% of GDP) with time horizon till 2070
  • 20.
  • 21. Fertility and the sustainability indicator • Alternative scenario with fertility rate of 1.2 instead of 1.45 • Small effect (0.3% of GDP) with time horizon till 2070 • Impact is doubled (to 0.6% of GDP) if time horizon is lengthened to 2085 - full account of effect of smaller labour force • But time horizon should be lengthened even longer - to take into account that number of pensioners ultimately fall, too • Likely zero effect in the very long run • Cf analysis for Norway by Statistics Norway
  • 22. Main conclusions 1. High-quality work by the Economic Policy Council - but analysis of link between employment policy and fiscal policy could be sharpened 2. Finland has a large fiscal sustainability problem - current policy does not appear well designed to address this problem Caveat: This is an outsider’s view But: Hard for an outsider to come to any other conclusion