Methods for Assessing Fiscal Sustainability in the IMF and EU

　The International Monetary Fund (IMF) and the European Commission (EC), the executive arm of the European Union (EU), are engaged in the quantitative assessment of a member country’s fiscal sustainability and sovereign risks. However, the methods of the assessment have significantly changed over the past 20 years with the experiences of the various fiscal shocks. At the beginning of the 2000s, these institutions were taking completely different approaches as to the time horizon and the indicators used for the assessment, but in recent years, there has been a converging trend with respect to the assessment methods.

　In assessing the short-term sovereign risks, mechanical assessment methods have been adopted by composing several indicators that are made by various fiscal and economic data. As for the medium-term sovereign risks, both the IMF and the EC are now commonly using a tool of debt sustainability analysis (DSA) based on realistic assumptions, as well as its statistical version (SDSA: stochastic debt sustainability analysis). In addition, the IMF actively adopts mechanical indicators for judging the sovereign risks considering the predicting power of the indicators. The EC assesses long-term fiscal sustainability using quantitative indicators (S1, S2) based on the projections for age-related expenditures such as pensions, medical care, and long-term care.

　The results of assessments by the IMF and the EC provide initial inputs for further contemplating appropriate policies, but they are critical inputs to reconsider how the current policies are assessed from the perspective of sovereign risks and fiscal sustainability. It should be noted that the prediction power of the mechanical indicators is calculated based on the experiences of past events and they cannot fully predict the future. That said, the various upgraded methods of assessing fiscal sustainability in IMF and EC help visualize the magnitude of sovereign risks by checking the reality of the baseline debt projections, considering alternative scenarios, and preparing for a stochastic distribution of sovereign debt. They are also expected to provide important insights to upgrade the methods of assessing sovereign risks and fiscal sustainability in Japan.

 

Keywords: Fiscal sustainability, Sovereign risk, Stochastic debt sustainability analysis

JEL Classification: C53, E27, I15

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Assessment of Japan’s Medium- to Long-term Sovereign Risks
―IMF’s SRDSF Assessment and Projections for Age-related Expenditures for Japan―

　This paper explains the results of the debt projections and the assessments of sovereign risks for Japan following the Sovereign Risk and Debt Sustainability Framework (SRDSF) conducted by the International Monetary Fund (IMF), which were published in March 2023. However, the assessment following the IMF’s SRDSF did not cover projections for age-related expenditures more than 10 years, which should have significant impacts on Japan’s public finances. Therefore, this paper also presents the results of projections for Japan’s healthcare and long-term care costs, as well as pension benefit costs until FY2060 prepared by referring to the methods adopted by the European Commission (EC).

 

Keywords: Fiscal sustainability, Sovereign stress, SRDSF, SDSA

JEL Classification: C53, E27, I15

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Research on the Sustainability of Employment Insurance Systems (Unemployment Benefits, Childcare Leave Benefits)

　With regard to employment insurance systems (unemployment benefits, childcare leave benefits), we analyzed the sustainability of employment insurance finances by building an estimation model based on available statistical data, published materials, and Japan’s employment insurance system, while taking reference from the approaches employed by the European Commission. Regarding unemployment benefits, the results of the analysis showed that reserved funds are not depleted in both the baseline and shock scenarios, and that employment insurance finance is sustainable under the assumption that the current system remains unchanged. Additionally, there is a correlation between equilibrium unemployment rate and insurance premium rate necessary to achieve balance of revenue and expenditure; in the model presented in this paper, a 1% rise in equilibrium unemployment rate corresponds to a 0.2% increase in insurance premium rate. In respect of childcare leave benefits, our analysis shows that reserved funds are not depleted in the baseline scenario under the assumption that the current system remains unchanged, however, changes in factors such as demographic changes (birth rates), household behavior (rate of women who continue to work after childbirth, rate of use of childcare leave), and employment policies (ratio of benefits received during childcare leave to wages (replacement rate)) have a corresponding impact on the amount of childcare leave benefits. As such, it is important to pay attention to the sustainability of employment insurance finances.

 

Keywords: Employment insurance finances, Unemployment benefits, Childcare leave benefits

JEL Classification: J21, H55

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Global safe asset imbalance and interest rates
―Long-term projection in the U.S. and China―

　This paper makes the long-term projection for the demand of global safe asset and investigates its impact on interest rates, using the two-country overlapping-generations model in the U.S. and China. The main findings are twofold: (i) if China's saving decreases due to the easing of its borrowing constraint by the financial development and the flattening of income distribution caused by the extension of retirement age, the current account imbalance between the U.S. and China would shrink; (ii) it would result in the exert upward pressure on real world interest rates.

 

Keywords: Current account balance, Demographic outlook for U.S. and China, Life cycle model, Savings rate, Interest rate

JEL Classification: F41, F47

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A Framework for Macroeconomic Analysis focusing on Net Lending/Borrowing across the Government, Private, and Overseas Sectors

　This paper develops a framework for macroeconomic analysis with a particular focus on net lending/borrowing across the government, private, and overseas sectors, which enables comprehensive and consistent analyses of the external balance of a country as well as the debt sustainability of public and private sectors. Specifically, we construct a partial equilibrium model for the Japanese economy that incorporates the linkages across sectors—government, household, non-financial corporations, financial corporations, and rest of the world—including both flow and stock variables. This model estimates the projection of income and outlay accounts for the public and private sectors based on a set of macroeconomic assumptions, including demographic trends, exchange rates, prices, and interest rates, and presents a consistent picture of how net lending/borrowing across sectors is expected to evolve over the long-run. The analysis of public debt sustainability, for example, can clearly illustrate the advantage of this model by presenting the long-term projection of public sector together with the overall picture of the economy, including the long-term projection of private and overseas sectors in a consistent manner.

　We present an illustrative scenario based on Japan’s current macroeconomic variables, including economic growth. In this scenario, the model shows that the current account surplus is projected to be sustained over the long-run, as an increase in the overseas earnings of corporate sector is expected to compensate for a gradual decline in households’ net lending and a gradual increase in fiscal deficit associated with an aging population. However, the continued current account surplus relies on corporations’ rate of return on external investments, suggesting the vulnerability to shocks from overseas economies. In contrast, under an alternative scenario that assumes increases in consumption propensity by households and investment propensity by corporations and consequent higher economic growth, the long-term projection of current account balance turns to a deficit due to a decline in net lending in the private sector and an increase in the fiscal deficit. This leads to the decline in the domestic absorbing capacity of government bonds, suggesting the increasing vulnerability of fiscal positions to interest rate shocks.

　Finally, this paper also employs a stochastic approach by using the probability distribution of macro variables, such as exchange rates, prices, and interest rates, for analyzing the implications of changes in these variables on the flows and stocks in each sector. The results show extremely large variations in the projections of external balances due to fluctuations in the respective macro variables and underscore the need to pay adequate attention to uncertainties associated with changes in parameters.

 

Keywords: Framework for macroeconomic analysis, Partial equilibrium model, Net lending/borrowing across sectors, Long-term projections for the Japanese economy

JEL Classification: C32, H68, D14

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