Fiscal sustainability andpolicy implications for the euro area

In this paper we examine the sustainability of euro area public finances against thebackdrop of population ageing. We critically assess the widely used projections of theWorking Group on Ageing Populations (AWG) of the EU's Economic PolicyCommittee and argue that ageing costs may be higher than projected in the AWGreference scenario. Taking into account adjusted headline estimates for ageing costs,largely based upon the sensitivity analysis carried out by the AWG, we consideralternative indicators to quantify sustainability gaps for euro area countries. Withrespect to the policy implications, we assess the appropriateness of different budgetarystrategies to restore fiscal sustainability taking into account intergenerational equity.Our stylised analysis based upon the lifetime contribution to the government's primarybalance of different generations suggests that an important degree of pre-funding of theageing costs is necessary to avoid shifting the burden of adjustment in adisproportionate way to future generations. For many euro area countries this impliesthat the medium-term targets defined in the context of the revised stability and growthpact would ideally need to be revised upwards to significant surpluses.[...] Fabrizio Balassone, Jorge Cunha, Geert Langenus, Bernhard Manzke, Jeanne Pavot, Doris Prammer, Pietro Tommasino