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This paper analyses long-term fiscal sustainability with a model which incorporates a number of feedback effects. When fiscal policy responds to ensure long-term sustainability, these feedback effects can potentially modify the intended outcomes by either enhancing or dampening the results of the policy interventions. The feedbacks include the effect on labour supply in response to changes in tax rates, changes in the country risk premium in response to higher public debt ratios, and endogenous changes in the rate of productivity growth and savings that respond to interest rates. A model of government revenue, expenditure and public debt which incorporates these feedbacks is used to simulate the outcome of a range of fiscal policy responses. In addition the effects of population ageing and productivity growth are explored.
We have benefited from discussions with Christopher Ball, Bob Buckle and Norman Gemmell. We should also like to thank Matthew Bell, Steve Cantwell, Martin Fukac, Ross Guest, Tony Makin, Patrick Nolan and Oscar Parkyn who provided helpful comments on an earlier draft.
The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate.
Table of Contents
- Executive Summary
- 1 Introduction
- 2 The Basic Model
- 3 Feedback Effects
- 4 Calibration of the Model
- 5 A Benchmark Simulation
- 6 Policies to Achieve Fiscal Sustainability
- 7 Conclusions
- Appendix A: Further Details of Model Calibration
- Appendix B: Solvency and Sustainability Indices