Helvi Kinnunen

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

This paper extends Gertlers (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 models dependency ratio.Variation in life expectancy is clearly much more important. Key words: ageing, general equilibrium, public finance, demographic uncertainty JEL classification numbers: E13, H55, J11, J26

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.

Bank relationships and small-business closures during the Finnish recession of the 1990s

The paper examines the role of bank relationships in business closures during the Finnish economic crisis of the early 1990s. We utilise a unique panel data set of 474 small and medium-sized firms, for which we have standard accounting information and for which we can in addition identify whether the firm had a lending relationship with the most troubled part of the banking system, namely the Savings Bank of Finland and Skopbank. By estimating a logit model we find that, even accounting for the effects of liquidity, profitability, indebtedness, age and size, firms that had a lending relationship with the savings banks concerned were more likely to close in 1992 than other firms that year or the same firms in other years. Thus being a loan customer of these banks entailed greater risk for firms than having a lending relationship with other intermediaries only in 1992, which was the year the banking sector came to a head. The result lends support to the hypothesis that financial factors affect real outcomes not only through firm and household balance sheets but also through bank behaviour.

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.

Population Ageing and Public Expenditure Trends in Finland

The impact of population ageing on public expenditure development in Finland is analysed by Kinnunen and Tuovinen. As in other countries, ageing will lead to an increase in expenditure on pensions and other welfare services. Other than the increase in spending due to the expected demographic developments, they observe that the risk of overrun in expenditure is mostly related to the production process in public services, given that the public sector in Finland is generally service-oriented. In order to contain the upward trend in costs, productivity developments in the public sector will have to be particularly relevant. The Authors note that if a positive productivity trend were to generate substantial cost containment, tax cuts could also be consistent with fiscal stability. However, this would imply a reversal of the negative productivity trend observed in recent years. Hence, it would be advisable that the adjustment of expenditure policy allows the government to face the possible negative growth and productivity scenarios.

Public Finances in the Euro Area: Growth Shocks and Structural Factors

Helvi Kinnunen and Pasi Kuoppamaki examine the sustainability of public finances in Finland and the four main euro area countries. The analytical framework is based on intertemporal budget dynamics. The paper shows that, in spite of the increase in age-related expenditure, the policies implicit in the 1997 primary budget balances would lead to a non-increasing debt ratio in almost all countries. The paper evaluates the implications of different growth and interest rate assumptions. The sensitivity calculations indicate that the response of the public debt and deficit ratios is stronger with respect to interest rate changes than it is to growth changes. However, the calculations show that a severe recession would lead to prolonged fiscal imbalances in some countries. Kinnunen and Kuoppamaki also estimate the tax-gaps, i.e. the change in the tax to GPD ratio, required to ensure debt stability or to fulfil the Stability and Growth Pact requirement of a balanced budget. The latter criterion is more demanding than the former. The authors note that comparisons of tax-gaps between countries should be considered very cautiously since they do not provide indications about the constraints that policymakers actually face. They also note that tax competition may significantly affect fiscal policy, in particular in highly taxed countries.