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Fiscal Impact of the Financial Crisis and Short Run Policy Responses

Fiscal Impact of the Financial Crisis and Short Run Policy Responses. Asta Zviniene The World Bank May 7, 2009. Part One. Central European pension systems before Financial crisis. Representative Pension System for Central Europe (Demographics and Coverage).

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Fiscal Impact of the Financial Crisis and Short Run Policy Responses

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  1. Fiscal Impact of the Financial Crisis and Short Run Policy Responses AstaZviniene The World Bank May 7, 2009

  2. Part One Central European pension systems before Financial crisis

  3. Representative Pension System forCentral Europe (Demographics and Coverage) • Based on the average of Bosnia, Lithuania, Serbia, Slovakia, Romania • Lower coverage of old women due to high survivor pension numbers • CIS, Baltics, Visegrad countries – almost universal coverage of the old • CIS – lower coverage of the young

  4. Representative Pension System forCentral Europe (1st pillar)

  5. Representative Pension System forCentral Europe (2nd pillar) • Pattern above is based on the average of Estonia, Hungary, Lithuania, Poland, and Slovakia • 2nd pillar contribution rate 7% (out of the total of 28%)

  6. Projections Before the Crisis • Figures assume that benefit levels and effective retirement ages do not change • Countries were hoping to mitigate the problem with 2nd pillars • Next let’s go to not so bad news: financial crisis…

  7. Part Two Likely impact of financial crisis

  8. Required Adjustment in Expectations Due to the Crisis • These are not adjustments from current levels, but adjustments from elevated expectations about the future • Wages and asset prices are likely to adjust similarly in the long run. Wage bill and revenues are likely to overshoot down in the short term…

  9. Formal Wage Bill fell more than GDP During Previous Financial Crises

  10. New Pensions will be Lower from Both Pillars • 2nd pillar pensions will depend on asset prices – most of the adjustment has likely already happened • Wages are in the process of adjusting • New pensions in the 1st pillar will adjust in the future as they will depend on lower future wages – adjustment hasn’t begun yet • Diversification: over-adjust from 1st, under-adjust from 2nd. In the long run likely to adjust similarly

  11. How will Pensions in Payment Adjust? • If adjustment of pensions to wages lags (by 1 year here) and pensions are not allowed to decrease in nominal terms then average replacement rates increase • This still could mean decline of living standards for pensioners if indexation is zero or below inflation! • Deficits are increasing because of higher replacement rates and because of the drop in coverage

  12. Main Findings: • Net present value of total Financial Crisis costs: 1%, 13%, 16% of GDP under mild, medium and severe crisis scenarios • Pensioners are not protected against inflation in the short run • Pensions from both 1st and 2nd pillar will be lower than previously expected, but timing of declines is different (diversification helps). Oldest 2nd pillar participants more vulnerable. • Notional systems would be affected similarly, since pensions in payment are often adjusted the same way as in conventional PAYG • Countries that index to combination of wages and prices will be starting from better fiscal position, but will be more sensitive to the financial crisis (pensions can not adjust to lower wages as fast). However, they will be better prepared for demographic crisis. • Financial crisis still pales in comparison with the demographic crisis

  13. Policy Interventions Attack both Crises at Once! • Price indexation: fiscal stimulus and pensioner protection now (borrowing might be needed), repayment and additional savings later • Reduce benefits to least vulnerable, take an opportunity to implement inevitable unpopular reforms (target early retirees, working pensioners and those with higher incomes & privileges) – eliminate wasteful programs, impose temporary solidarity tax, increase retirement age • Increase contributions – would mean higher future pensions in Notional systems, might hurt economy further • Tap into the 2nd pillar – temporarily suspend contributions, allow switchers to return – wasn’t the demographic crisis a bigger problem? Only last resort temporary measure until long term solutions can be found

  14. Part Three Evaluation of Policy Interventions(assuming a crisis of medium severity)

  15. Switching to Price Indexation

  16. Combining Price Indexation with Ret Age Increase (men 2y, women 4y) • Short term problem still remains. Ideally, money could be borrowed (even from pension funds), but some countries chose to tap 2nd pillar…

  17. Tapping the 2nd pillar • Pension levels change negligibly in this case (more generally this depends on the generosity of the PAYG) • Pension fund industry destabilized • Long term deficits deteriorate • Similar outcomes from allowing switchback to PAYG, but switchback is harder to reverse than contribution rate reductions • Can only be temporary solution until price indexation and retirement age increase start to substantially reduce expenditures

  18. Thank you

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