Promises, Promises. Better Measuring the Effect of Pension Reform
IMF Blog, April 26, 2011
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Bibliographic details
- Authors: Benedict Clements
- Published: April 26, 2011
Overview and context
- Author: Benedict Clements
- Date: April 26, 2011
- Core issue: Public pension promises resemble future government debt; traditional deficit and debt indicators focus on current public finances and often fail to capture the long-term fiscal impact of pension promises.
- Policy motivation: Pension reform is a priority for advanced economies (current trends unsustainable) and for many emerging and low-income economies that need "to improve coverage of health and pension systems in a fiscally sound manner."
Problems identified
- Traditional fiscal indicators:
- Focus on the health of public finances today, but fail to capture the future impact of pension promises.
- Can create incentives to delay or reverse pension reforms because reforms that improve long-term fiscal health might not improve—and can sometimes worsen—traditional fiscal indicators today.
- Specific consequence:
- Reforms that divert contributions to second pillar systems with mandatory private accounts can worsen headline balances in the short term despite reducing long-term pension liabilities.
The "pension-adjusted" budget balance (new indicator)
- Purpose:
- Gives governments credit for pension reforms that improve long-term fiscal health, while signalling when they move in the wrong direction.
- Provides a level playing field for evaluating a country’s pension policies.
- Definition and calculation (simplified description from source):
- Recalculates the traditional budget balance to take into account the intertemporal pension balance (future pension imbalances), rather than the current pension balance.
- Takes account of the difference between the current value of future pension contributions and the current value of all future benefits, from today to a certain date in the future, say 50 years.
- Conceptual distinctions:
- Headline and pension-adjusted balances are annual flow concepts.
- The NPV (net present value) of pension liabilities is a stock concept and is much higher as a percent of a single year’s GDP.
- Empirical observation (from Figure 1 discussion):
- Reforms had a large impact on the NPV of net pension liabilities, even though headline balances are worse after the reforms because of the diversion of contributions to second pillar systems with mandatory private accounts.
- The pension-adjusted balance improves with reforms that reduce the NPV of pension liabilities, eliminating incentives to adopt or dismantle particular systems to improve current-period fiscal indicators.
Policy design implications and recommendations
- The indicator can help measure when changes in pension policies are improving or worsening long-term fiscal health; it eliminates incentives to adopt or dismantle particular systems to improve current-period indicators, while acknowledging that overall balances remain key for short-term financing risk assessment.
- Three main implications for fiscal policy design (verbatim from source):
- We should take account of the future impact of pension reforms, or other public programs such as health care, when we analyze fiscal sustainability.
- To do that, we should look at the sum of future pension balances, the intertemporal pension balance.
- The "pension-adjusted" budget balance should be viewed as a complement, rather than a substitute, for traditional fiscal indicators.
Benedict Clements, April 26, 2011 — Promises, Promises. Better Measuring the Effect of Pension Reform
Content in this bundle
- Fiscal Monitor - Shifting Gears Tackling Challenges on the Road to Fiscal Adjustment - April 2011
- Staff Discussion Note
