The Sources of Output Shocks in Finland and Other EU Countries

This paper examines the sources of output shocks in Finland as compared to other EU countries. The data consists of output fluctuations in main industries in nine current EU countries for the period 1978–1993. The sources of output shock are considered to consist of country-specific factors, sector-specific factors and a time factor, which is common to all countries and sectors. Fluctuation is partitioned using three-dimensional analysis of variance. Output shocks in Finland are clearly more country-specific than in other EU countries. A separate examination of the time period preceding the 1990s demonstrates that the result is not due to the exceptional recession in the beginning of the 1990s. The more central role that the country-specific factor has in Finland as compared to other EU countries is explained by the fact that average output growth was higher in Finland than in other EU countries until the end of the 1980s. Differences in growth rates between sectors also were larger than in other countries. Examination of the time period including the recession revealed that idiosyncratic economic cycle was clearly a more significant source of disturbances in Finland than in other countries. Examining the time period covering the depression also underlines the large volatility of the sheltered sector in Finland.output shocks; output by industry; variance partitioning; EU countries

Government funds and demographic transition – alleviating ageing costs in a small open economy

This paper investigates public pension funding using a dynamic general equilibrium macroeconomic model (DSGE) that facilitates investigation of distortionary effects of fiscal and pension policy responses to ageing. The model is calibrated to the Finnish economy, which will encounter substantial ageing pressures in the near future. During the transition to an older population structure ageing costs can be substantially lowered by allowing public funds to smooth out the tax responses. Cutting down on pension prefunding at a time when the pace of ageing is at its peak reduces the necessary tax hikes and stimulates labour supply growth at the moment when the labour market is tightest. With smaller funding needs, ageing leads to a slower growth in labour costs, a better employment conditions and faster production growth.ageing; general equilibrium; public finance; government funds

Real time analysis of euro area fiscal policies: adjustment to the crisis

Using real time data from the OECD and fiscal policy reaction functions, this study explores euro area fiscal policies since the late 1990s. Both discretionary plans for the budget year and policy changes during budget implementation stages are investigated. The main focus is on the fiscal adjustment to the recent financial and economic crisis. The results suggest that during the time of monetary union (EMU) euro area planned fiscal policies have been long-term oriented and counter-cyclical. In the implementation stages new policy decisions have been made in response to unexpected economics developments. We provide evidence that the crisis had a clear impact on discretionary policies. Due to the resultant increase in uncertainty, the crisis spotlighted the impact of cyclical developments on fiscal planning. In the implementation stages, huge forecast errors in connection with planned policy were observed. As a consequence, new decisions were made in order to alleviate the negative impacts of the crisis on euro area economies.fiscal policy; real time data; planning stage; implementation stage; cyclical sensitivity; economic crisis

Population ageing, labour markets and the outlook for public finances

Keeping public finances on a sustainable foundation while the population ages is clearly a problem in Finland, as in many other western countries. The shrinking of the working-age population, ageing of the labour force, and growth in the number of very old persons form a difficult combination vis-à-vis sustainable public finances. An age structure that is changing in unfavourable ways has long-run consequences for balance of public finances and room for fiscal policy. With structural unemployment lodged at a high level and the average age of the labour force trending upward in the coming years, the financial foundation for public services is on the decline. Calculations extending the Bank of Finland’s 2004-horizon forecast indicate that if definite changes in retirement rates are not forthcoming, the pressure for tax tightening in the near future will be conspicuous. The projections show that pension reform alone will not dispel the pressure for tax increases. But if, in addition to pension reform, the productivity of service production in the public sector is boosted, ageing will not necessarily lead to tax tightening.population ageing, tax rate, pension reform, efficiency of public sector

Population ageing, labour markets and the outlook for public finances

Keeping public finances on a sustainable foundation while the population ages is clearly a problem in Finland, as in many other western countries. The shrinking of the working-age population, ageing of the labour force, and growth in the number of very old persons form a difficult combination vis-à-vis sustainable public finances. An age structure that is changing in unfavourable ways has long-run consequences for balance of public finances and room for fiscal policy. With structural unemployment lodged at a high level and the average age of the labour force trending upward in the coming years, the financial foundation for public services is on the decline. Calculations extending the Bank of Finland’s 2004-horizon forecast indicate that if definite changes in retirement rates are not forthcoming, the pressure for tax tightening in the near future will be conspicuous. The projections show that pension reform alone will not dispel the pressure for tax increases. But if, in addition to pension reform, the productivity of service production in the public sector is boosted, ageing will not necessarily lead to tax tightening.population ageing; tax rate; pension reform; efficiency of public sector

Population ageing in a small open economy – some policy experiments with a tractable general equilibrium model

This paper extends Gertler’s (1999) tractable overlapping generations model with life-cycle features by allowing for distortionary taxation, demographic transition and stochastic variation in demographic structure. The model is then used to study demographic change in the small open economy of Finland. Simulations highlight the key role played by labour market responses to ageing. When the responses of labour supply, wages, and hence private consumption, to higher taxation are consistently accounted for, population ageing has clearly much larger effects on public finance, when compared to mechanical sustainability calculations. Stochastic simulations suggest that lengthening of working time has only a modest alleviating effect on the fiscal burden of ageing. This is due to the fact that stochastic variation in the length of working time has only a relatively small effect on the model’s dependency ratio. Variation in life expectancy is clearly much more important.ageing; general equilibrium; public finance; demographic uncertainty

Demographic Uncertainty and Labour Market Imperfections in Small Open Economy

This paper extends Gertler's (1999) tractable overlapping generations model by allowing for imperfect labour markets and distortionary taxation. Furthermore, we allow for stochastic variation in demographic structure. The model is then used to study demographic change in a small open economy of Finland. The simulations highlight a key role played by labour market imperfections in determining a fiscal burden of ageing in defined benefit pensions systems. Higher labour market imperfections lead into considerably stronger responses of labour supply and taxes on ageing. Thus, imperfections magnify the problem associated with fiscal sustainability in ageing society. Higher labour market imperfections lead into considerably stronger responses of labour supply and taxes on ageing. Thus, imperfections magnify the problem associated with fiscal sustainability in ageing society. Stochastic simulations suggest that lengthening of working time has rather minor impact on alleviating the fiscal burden of ageing. Only a small fraction of the stochastic variation in endogenously determined contribution rate is explained by the stochastic variation in the lenght of working time. Variation in fertility rate is clearly more important.Demographics, Uncertainty, DSGE, Labour Markets

Sustainability of Public Finances in Finland and the Four Largest Euro-area Economies

The paper analyses the sustainability of fiscal policy in the four largest countries of the EMU area and Finland with the aim of assessing whether current fiscal policies are compatible with the Stability and Growth Pact in the medium term. The sensitivity of the deficit and debt ratios to changes in the real interest rate and economic growth is also assessed. Moreover, since population ageing will cause an extra burden on public finances, the fiscal pressure of rising pension costs in the longer term is also investigated. The baseline calculations for the medium term suggest that fiscal policy is sustainable in all countries except perhaps France. However, highly indebted countries such as Italy are clearly more sensitive to changes in interest rates. The results indicate that there is little or no room for active fiscal policy. The room for manoeuvre is even more limited if one takes into account that tax rates most likely need to be lowered in many countries, especially in Finland and Italy, due to tax harmonisation and tax competition. Moreover, population ageing will impose pressures on public finances in the long run. Only Finland and Italy seem to be in a position to cope with increasing pension expenditures over the long run.public finance; sustainability; stability pact; tax competition; ageing; pensions

Competitiveness and the export performance of the euro area

Chapter 1 provides an overview and assessment of the price competitiveness and export performance of the euro area and the larger euro area countries, as well as an evaluation of how standard equations have been able to explain actual export developments. Chapter 2 carries out a constant market share analysis for the euro area and thereby sheds light on the reasons for movements in aggregate export market shares by looking at the sectoral and geographical composition of euro area exports. Chapter 3 looks at the evolution of the technological competitiveness of the euro area and major competitors – proxied by patenting activity and R&D expenditure – and analyses some structural indicators of competitiveness using survey data. Chapter 4 then looks at the impact of FDI on competitiveness and export performance. Finally, Chapter 5 summarises the main findings of the report, but also critically evaluates their importance and implications.

Fiscal sustainability and policy implications for the euro area" by

Abstract In this paper we examine the sustainability of euro area public finances against the backdrop of population ageing. We critically assess the widely used projections of the Working Group on Ageing Populations (AWG) of the EU's Economic Policy Committee and argue that ageing costs may be higher than projected in the AWG reference scenario. Taking into account adjusted headline estimates for ageing costs, largely based upon the sensitivity analysis carried out by the AWG, we consider alternative indicators to quantify sustainability gaps for euro area countries. With respect to the policy implications, we assess the appropriateness of different budgetary strategies to restore fiscal sustainability taking into account intergenerational equity. Our stylised analysis based upon the lifetime contribution to the government's primary balance of different generations suggests that an important degree of pre-funding of the ageing costs is necessary to avoid shifting the burden of adjustment in a disproportionate way to future generations. For many euro area countries this implies that the medium-term targets defined in the context of the revised stability and growth pact would ideally need to be revised upwards to significant surpluses