Debt projections and fiscal sustainability with feedback effects

Abstract

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.

How Uncertain Are Long-Run Fiscal Projections? Non-Parametric Stochastic Modelling for New Zealand

“…The basic structure of the model is described in Figure ; further details are in Appendix 1 and Creedy and Scobie (). The shaded boxes indicate components that influence other variables: these include the income tax and GST structure, the incentive effect of taxes, the demographic structure of the population and productivity and expenditure growth rates.…”

“…The aim of the present article is to explore this alternative procedure to examine stochastic tax revenue, expenditure and government debt projections in the New Zealand context. The stochastic projections build on the model of Creedy and Scobie (), which was designed to allow for a number of important feedback effects that are also typically neglected in projection models. Rather than attempting to capture all the details involved in the many types of expenditure and tax, the model uses a much more aggregative approach.…”

The Timing of Income Tax Changes in the Face of Projected Debt Increases

“…In particular, distinctions are drawn between those of working age, retirement age and those below working age. The basic model used here is presented in full in Creedy and Scobie (). It essentially takes the form of a ‘bottom‐up’ projection approach widely used by government departments around the world, but adds feedback effects.…”

“…The calibration of the model involves setting a large number of initial variables and parameter values, obtained using an extensive range of New Zealand data; see Creedy and Scobie (, Tables A1 to A6). An important feature of the model is that, when the feedback and uncertainty features are ‘turned off', it produces benchmark 40‐year projections of the government debt ratio that closely match those produced by the more disaggregated Treasury Long Term Fiscal Model: see Bell and Rodway ().…”

“…Full details of the data on which these values are based are provided in Creedy and Scobie (, Appendix A).…”