## Box 1. Assumptions for Debt Simulations ## Source details **Canonical URL:** [Box 1. Assumptions for Debt Simulations](https://www.imf.org/-/media/files/publications/imf-notes/2025/english/insea2025004.pdf) ## Other formats - [Markdown version](/-/media/files/publications/imf-notes/2025/english/insea2025004.pdf.md) - [Structured JSON version](/-/media/files/publications/imf-notes/2025/english/insea2025004.pdf.json) --- ### Overview and key scenarios - Spending pressures considered: health, pensions, defense, and climate. - Estimated increase in spending above current levels by 2040: - "about 4½ percentage points of GDP by 2040 on average in advanced economies (excluding Central, Eastern, and South-Eastern Europe (CESEE))" - "5½ percentage points of GDP in CESEE countries" - No-policy-action debt projections: - "debt of the average European country would reach 130 percent of GDP by 2040" - "155 percent on a GDP-weighted average basis" - Accounting for debt-growth feedbacks: - Studies find "a 10 percentage point increase in the debt ratio lowers annual real GDP growth by about 0.05–0.2 percentage points, once debt exceeds 75 percent of GDP" - Including this mechanism, average debt ratio would reach "about 150 percent of GDP by 2040 (or close to 190 percent GDP-weighted)" - Assumption on interest-growth differential feedback: - "the interest rate-GDP growth differential increases by 4 basis points for every one percentage point increase in the debt-to-GDP ratio above 75 percent of GDP" ### Reference debt anchor and tailoring across countries - Two-step calibration produces a debt anchor used in simulations: - Estimated average country-specific debt limit (cliff): "about 105 percent of GDP" - Estimated average buffer below the cliff: "about 15 percent of GDP" - Resulting illustrative debt anchor applied: "approximately 90 percent of GDP on average" - Stylized treatment by current debt level: - Countries with debt > 90 percent of GDP: "target debt stabilization over the next five years and put it on a declining path in the subsequent decade" - Countries with debt < 90 percent of GDP: assumed to "keep fiscal policy 'unchanged' (unless the debt drift because of spending pressures eventually leads to a breach of the 90 percent threshold)" ### Reform packages and their quantified effects - Components considered: - Domestic growth-enhancing reforms (product and labor market, governance, credit and capital markets) - First-step single market deepening and integration measures - Doubling of the EU budget for innovation, defense, and energy financed through joint borrowing (centralization) - Public pension reforms (increasing contributions, raising retirement age, lowering benefits) - Catalyzing private investment through de-risking instruments - Quantified output effects (assumptions used in simulations): - Domestic reforms: "boost the level of output over the medium term by about 5 percent in European advanced economies and 7 percent in CESEE countries" - First-step single market actions: "increase the level of output in EU countries by 3 percent over 10 years" - Impact of reform packages on debt trajectory (simple average of European countries): - No reforms: 2040 debt = "130 percent of GDP" - "Ambitious" reform package: 2040 debt ≈ "about 105 percent of GDP" - "Moderate" reform package (half as ambitious): 2040 debt ≈ "about 115 percent of GDP" - Contribution shares: - "The largest impact comes from pension reforms and growth-enhancing domestic reforms" - Growth-enhancing reforms (domestic + single market) "account for around two-thirds of the impact of the reform package" ### Fiscal consolidation needs and interactions with reforms - Consolidation sizing assumptions: - Consolidation occurs "over the next five years to build buffers" - For countries needing adjustment after "moderate" reforms, average required improvement: "an annual improvement in the cyclically adjusted primary balance of about ¾ percent of GDP per year over the assumed five-year consolidation period (cumulatively slightly above 3½ percent of GDP)" - Heterogeneity: - Many smaller advanced economies: "no adjustment needs or modest ones of less than 2 percent of GDP cumulatively" - CESEE countries: "tend to require more consolidation—in the 2–5 percent of GDP range" - Several large advanced economies: "would need to improve by more than 5 percent of GDP over five years" - Sensitivity to reform ambition: - Moving from "moderate" to "ambitious" reduces cumulative consolidation for the average country "by close to 1 percent of GDP (from 3.7 percent of GDP to 2.9 percent of GDP)" - Accounting for fiscal multipliers (growth impact of consolidation): - Including multipliers increases required adjustment "by about ¼ percent of GDP per year, bringing the cumulative fiscal consolidation close to 5 percent of GDP for the average country" - Multiplier exercise assumption: "aggregate fiscal multiplier of 1, on impact, which decays linearly to zero over five years" - Cost of delay: - Delaying the policy package by five years raises required medium-term consolidation from "¾ percent of GDP per year to over 1 percent of GDP per year" ### Options when reforms and consolidation are insufficient - For about one-quarter of European countries, "consolidation of above one percent per year for five years would be required" after "moderate" reforms—exceeding what has typically been feasible. - Rethinking the role and perimeter of government may be necessary: - Differentiate between "basic" and "premium" services across health, education, pensions, social protection - Potential measures: selling/closing loss-making state-owned enterprises; better targeting welfare; cutting energy subsidies; rationalizing public wage bill; introducing higher charges for higher-income users - Potential fiscal gains from shifting public–private financing shares: - Aligning public financing shares (health, education, pensions, infrastructure, climate) with OECD average could "generate fiscal savings of close to 3 percent of GDP per year for the average European country" - Design considerations: - Changes should protect the vulnerable (means-testing, user charges with protections) - Deep tax reforms can be designed progressively ### Policy recommendations and strategic principles - No silver bullet: "A multipronged strategy is best, leveraging all policy tools at national and regional levels" - Combine reforms and fiscal consolidation: "Both are necessary in most European countries" - Prepare for difficult choices on the role of government: "Even with bold reforms and fiscal discipline, financing gaps are likely to persist, especially in high-debt countries" - Emphasize extensive public consultation and communication: - Initiate public discussion about the scale and costs of inaction - Produce and publish credible long-term fiscal forecasts and strategic plans regularly - Use systematic expenditure reviews to guide country-specific strategies ### Reference debt path: calibration and primary balance dynamics (2026–40) - Simulations cover 2026–40 for each country. - Starting point for the primary balance: the country’s average cyclically adjusted primary balance during 2023–25 (rather than 2025) to smooth cyclical and one-off factors. - Primary balance evolves each year because of four factors: - (1) Annual adjustment needs: - Countries with debt initially below 90 percent of GDP at the end of 2025: no adjustment is required, unless needed to keep debt below 90 percent of GDP during 2026–40. - Countries with debt above 90 percent of GDP in 2025: assumed to consolidate in a linear way over the first five years in order to just stabilize debt by the fifth year, and put it on a continuously declining path for the next 10 years (while not falling below 90 percent of GDP). - (2) Spending pressures during 2026–40 in health, pensions, defense, and climate (based on Eble and others (2025)): - Defense pressures updated to reflect NATO commitment to increase core spending to 3.5 percent of GDP by 2035. - These pressures cause the initial primary balance to deteriorate over time, implying additional spending of approximately 4½ percentage points of GDP by 2040 on average in advanced economies (excluding CESEE) and 5½ percentage points of GDP in CESEE countries. - (3) A cyclical component during 2026–30 based on World Economic Outlook projections. - (4) Stock-flow adjustments based on country-specific medians over time during 2001–24 (0.7 percent of GDP per year, on average across countries). ### Macroeconomic assumptions for growth and interest rates - GDP growth and the effective interest rate on government debt are based on World Economic Outlook projections until 2030. - From 2031 to 2040: - GDP growth is assumed to remain at its 2030 pace. - The effective interest rate is adjusted gradually to align with yields on each country’s 10-year bonds during 2023–25, where available, to reflect recent borrowing costs. - The average interest rate-growth differential is close to −1 percent in the sample by 2040. ### Incorporation of selected reforms: timing and fiscal effects - Fiscal consolidation occurs over five years (2026–30). - Reforms are implemented gradually and pay off over the longer term (during 2031–40). - The effect of growth-enhancing reforms on the fiscal position is calibrated using empirically estimated elasticities, implicitly assuming that not all additional revenues are saved (Heimberger 2023). ### Assumed reforms and their calibrated impacts - Domestic reforms: - Assumes the three structural reforms with the largest payoff identified by Budina and others (2025) are implemented in a sequenced way over the next 15 years, beginning to affect growth after 2030. - Reforms: (1) business regulation (planning reform, cutting red tape, easier firm entry); (2) labor markets (training, loosening employment protection, lowering labor tax wedges); (3) governance (control of corruption). - Impact: cumulatively increases the level of GDP by 4¾ percent on average across European countries by 2040. - Single market: - Reforms that strengthen the single market are assumed to be implemented over the next five years and impact growth during 2031–40. - Impact: lifts the level of GDP in EU countries by 3 percent by 2040. - Centralization: - Assumes a doubling of the EU budget allocation to defense and climate, financed by joint EU borrowing (as proposed by Busse and others (2025)). - Effects: eases fiscal pressures on national budgets, delivers efficiency gains, and yields interest savings of 0.47 percent of GDP for EU countries during 2030–40. - Catalyzation: - Policy banks in all countries are assumed to increase investment by 0.3 percent of GDP (calibrated on the difference between BPI-France and KfW-Germany). - With a typical leverage ratio of 1.8, this crowds in additional private investment so that spending pressures are estimated to be reduced by 0.25 percent of GDP per year in all countries during 2031–40 on a net basis. - Pensions: - Reforms to public pensions are assumed to gradually eliminate all spending pressures from pensions by 2030 (IMF 2011; Fouejieu and others 2021). *REGIONAL ECONOMIC OUTLOOK—Europe, INTERNATIONAL MONETARY FUND | November 2025* ### References ............................................................................................................. ### References ### Listing - References .......................................................................................................................................................... 13 - B - ox *Source: insea2025004 - References* ### Box 1. Assumptions for Debt Simulations . ### Box 1. Assumptions for Debt Simulations ### Overview and key scenarios - Spending pressures considered: health, pensions, defense, and climate. - Estimated increase in spending above current levels by 2040: - "about 4½ percentage points of GDP by 2040 on average in advanced economies (excluding Central, Eastern, and South-Eastern Europe (CESEE))" - "5½ percentage points of GDP in CESEE countries" - No-policy-action debt projections: - "debt of the average European country would reach 130 percent of GDP by 2040" - "155 percent on a GDP-weighted average basis" - Accounting for debt-growth feedbacks: - Studies find "a 10 percentage point increase in the debt ratio lowers annual real GDP growth by about 0.05–0.2 percentage points, once debt exceeds 75 percent of GDP" - Including this mechanism, average debt ratio would reach "about 150 percent of GDP by 2040 (or close to 190 percent GDP-weighted)" - Assumption on interest-growth differential feedback: - "the interest rate-GDP growth differential increases by 4 basis points for every one percentage point increase in the debt-to-GDP ratio above 75 percent of GDP" ### Reference debt anchor and tailoring across countries - Two-step calibration produces a debt anchor used in simulations: - Estimated average country-specific debt limit (cliff): "about 105 percent of GDP" - Estimated average buffer below the cliff: "about 15 percent of GDP" - Resulting illustrative debt anchor applied: "approximately 90 percent of GDP on average" - Stylized treatment by current debt level: - Countries with debt > 90 percent of GDP: "target debt stabilization over the next five years and put it on a declining path in the subsequent decade" - Countries with debt < 90 percent of GDP: assumed to "keep fiscal policy 'unchanged' (unless the debt drift because of spending pressures eventually leads to a breach of the 90 percent threshold)" ### Reform packages and their quantified effects - Components considered: - Domestic growth-enhancing reforms (product and labor market, governance, credit and capital markets) - First-step single market deepening and integration measures - Doubling of the EU budget for innovation, defense, and energy financed through joint borrowing (centralization) - Public pension reforms (increasing contributions, raising retirement age, lowering benefits) - Catalyzing private investment through de-risking instruments - Quantified output effects (assumptions used in simulations): - Domestic reforms: "boost the level of output over the medium term by about 5 percent in European advanced economies and 7 percent in CESEE countries" - First-step single market actions: "increase the level of output in EU countries by 3 percent over 10 years" - Impact of reform packages on debt trajectory (simple average of European countries): - No reforms: 2040 debt = "130 percent of GDP" - "Ambitious" reform package: 2040 debt ≈ "about 105 percent of GDP" - "Moderate" reform package (half as ambitious): 2040 debt ≈ "about 115 percent of GDP" - Contribution shares: - "The largest impact comes from pension reforms and growth-enhancing domestic reforms" - Growth-enhancing reforms (domestic + single market) "account for around two-thirds of the impact of the reform package" ### Fiscal consolidation needs and interactions with reforms - Consolidation sizing assumptions: - Consolidation occurs "over the next five years to build buffers" - For countries needing adjustment after "moderate" reforms, average required improvement: "an annual improvement in the cyclically adjusted primary balance of about ¾ percent of GDP per year over the assumed five-year consolidation period (cumulatively slightly above 3½ percent of GDP)" - Heterogeneity: - Many smaller advanced economies: "no adjustment needs or modest ones of less than 2 percent of GDP cumulatively" - CESEE countries: "tend to require more consolidation—in the 2–5 percent of GDP range" - Several large advanced economies: "would need to improve by more than 5 percent of GDP over five years" - Sensitivity to reform ambition: - Moving from "moderate" to "ambitious" reduces cumulative consolidation for the average country "by close to 1 percent of GDP (from 3.7 percent of GDP to 2.9 percent of GDP)" - Accounting for fiscal multipliers (growth impact of consolidation): - Including multipliers increases required adjustment "by about ¼ percent of GDP per year, bringing the cumulative fiscal consolidation close to 5 percent of GDP for the average country" - Multiplier exercise assumption: "aggregate fiscal multiplier of 1, on impact, which decays linearly to zero over five years" - Cost of delay: - Delaying the policy package by five years raises required medium-term consolidation from "¾ percent of GDP per year to over 1 percent of GDP per year" ### Options when reforms and consolidation are insufficient - For about one-quarter of European countries, "consolidation of above one percent per year for five years would be required" after "moderate" reforms—exceeding what has typically been feasible. - Rethinking the role and perimeter of government may be necessary: - Differentiate between "basic" and "premium" services across health, education, pensions, social protection - Potential measures: selling/closing loss-making state-owned enterprises; better targeting welfare; cutting energy subsidies; rationalizing public wage bill; introducing higher charges for higher-income users - Potential fiscal gains from shifting public–private financing shares: - Aligning public financing shares (health, education, pensions, infrastructure, climate) with OECD average could "generate fiscal savings of close to 3 percent of GDP per year for the average European country" - Design considerations: - Changes should protect the vulnerable (means-testing, user charges with protections) - Deep tax reforms can be designed progressively ### Policy recommendations and strategic principles - No silver bullet: "A multipronged strategy is best, leveraging all policy tools at national and regional levels" - Combine reforms and fiscal consolidation: "Both are necessary in most European countries" - Prepare for difficult choices on the role of government: "Even with bold reforms and fiscal discipline, financing gaps are likely to persist, especially in high-debt countries" - Emphasize extensive public consultation and communication: - Initiate public discussion about the scale and costs of inaction - Produce and publish credible long-term fiscal forecasts and strategic plans regularly - Use systematic expenditure reviews to guide country-specific strategies *Box 1. Assumptions for Debt Simulations.* ### Box 1. Assumptions for Debt Simulations ### Box 1. Assumptions for Debt Simulations ### Reference debt path: calibration and primary balance dynamics (2026–40) - Simulations cover 2026–40 for each country. - Starting point for the primary balance: the country’s average cyclically adjusted primary balance during 2023–25 (rather than 2025) to smooth cyclical and one-off factors. - Primary balance evolves each year because of four factors: - (1) Annual adjustment needs: - Countries with debt initially below 90 percent of GDP at the end of 2025: no adjustment is required, unless needed to keep debt below 90 percent of GDP during 2026–40. - Countries with debt above 90 percent of GDP in 2025: assumed to consolidate in a linear way over the first five years in order to just stabilize debt by the fifth year, and put it on a continuously declining path for the next 10 years (while not falling below 90 percent of GDP). - (2) Spending pressures during 2026–40 in health, pensions, defense, and climate (based on Eble and others (2025)): - Defense pressures updated to reflect NATO commitment to increase core spending to 3.5 percent of GDP by 2035. - These pressures cause the initial primary balance to deteriorate over time, implying additional spending of approximately 4½ percentage points of GDP by 2040 on average in advanced economies (excluding CESEE) and 5½ percentage points of GDP in CESEE countries. - (3) A cyclical component during 2026–30 based on World Economic Outlook projections. - (4) Stock-flow adjustments based on country-specific medians over time during 2001–24 (0.7 percent of GDP per year, on average across countries). ### Macroeconomic assumptions for growth and interest rates - GDP growth and the effective interest rate on government debt are based on World Economic Outlook projections until 2030. - From 2031 to 2040: - GDP growth is assumed to remain at its 2030 pace. - The effective interest rate is adjusted gradually to align with yields on each country’s 10-year bonds during 2023–25, where available, to reflect recent borrowing costs. - The average interest rate-growth differential is close to −1 percent in the sample by 2040. ### Incorporation of selected reforms: timing and fiscal effects - Fiscal consolidation occurs over five years (2026–30). - Reforms are implemented gradually and pay off over the longer term (during 2031–40). - The effect of growth-enhancing reforms on the fiscal position is calibrated using empirically estimated elasticities, implicitly assuming that not all additional revenues are saved (Heimberger 2023). ### Assumed reforms and their calibrated impacts - Domestic reforms: - Assumes the three structural reforms with the largest payoff identified by Budina and others (2025) are implemented in a sequenced way over the next 15 years, beginning to affect growth after 2030. - Reforms: (1) business regulation (planning reform, cutting red tape, easier firm entry); (2) labor markets (training, loosening employment protection, lowering labor tax wedges); (3) governance (control of corruption). - Impact: cumulatively increases the level of GDP by 4¾ percent on average across European countries by 2040. - Single market: - Reforms that strengthen the single market are assumed to be implemented over the next five years and impact growth during 2031–40. - Impact: lifts the level of GDP in EU countries by 3 percent by 2040. - Centralization: - Assumes a doubling of the EU budget allocation to defense and climate, financed by joint EU borrowing (as proposed by Busse and others (2025)). - Effects: eases fiscal pressures on national budgets, delivers efficiency gains, and yields interest savings of 0.47 percent of GDP for EU countries during 2030–40. - Catalyzation: - Policy banks in all countries are assumed to increase investment by 0.3 percent of GDP (calibrated on the difference between BPI-France and KfW-Germany). - With a typical leverage ratio of 1.8, this crowds in additional private investment so that spending pressures are estimated to be reduced by 0.25 percent of GDP per year in all countries during 2031–40 on a net basis. - Pensions: - Reforms to public pensions are assumed to gradually eliminate all spending pressures from pensions by 2030 (IMF 2011; Fouejieu and others 2021). *REGIONAL ECONOMIC OUTLOOK—Europe, INTERNATIONAL MONETARY FUND | November 2025* --- _Source: https://www.imf.org/-/media/files/publications/imf-notes/2025/english/insea2025004.pdf_