NOMBRE DEL DEPARTAMENTO 1
Public finances and inflation:
the case of Spain
PRELIMINARY WORK
Javier J. Pérez (Banco de España)
Joint work with S. Hurtado, F. Martí, and P. Hernández
This presentation does not necessarily reflect the opinions of the Banco de
España or the Eurosystem
Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
2
Overview
Implications of a low inflation environment for…
Fiscal consolidation (some accounting examples)
PUBLIC DEBT: The consolidation episode of the 1990s vs now
PUBLIC SPENDING: impact of measures in a low-inflation framework
PUBLIC REVENUE: limits to tax collection
Some simulations using Bank of Spain’s MTBE
INFLATION SHOCKS: inspecting the channels - oil prices, profit margins
Medium-term fiscal sustainability safeguards
PENSION SUSTAINABILITY: the “revaluation index”
Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
3
Overview
Inflation and inflation expectations in Spain
Departamento de Coyuntura y
Previsión Económica
HCPI: SPAIN AND THE EURO AREA
-1
0
1
2
3
4
5
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Spain Euro zone
% RATE OF CHANGE
SOURCE: Noational Statistics Institute
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
2012 2013 2014
Spring 2011 Autumn 2011 Spring 2012 Autumn 2012
Spring 2013 Autumn 2013 Spring 2014 Autumn 2014
% growth of the private consumption deflator
EUROPEAN COMMISSION INFLATION FORECASTS FOR SPAIN
NOMBRE DEL DEPARTAMENTO
Inflation and wage growth
Public finances and inflation: the case of Spain
4Departamento de Coyuntura y
Previsión Económica
COMPENSATION PER EMPLOYEE AND CONSUMER PRICES .
-2
0
2
4
6
8
10
12
14
16
18
1981 1986 1991 1996 2001 2006 2011
Compensatio per employee CPI
% RATE OF CHANGE
SOURCE: Noational Statistics Institute and Banco de España
Overview
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
5
Fiscal consolidation
Inflation and public debt reduction
Standard
decomposition
of debt changes:
- Budget balance
- Real GDP
- GDP deflator
- Def.-debt adj.
Departamento de Coyuntura y
Previsión Económica
D bt = (it - gt)/(1+ gt) bt-1 + pbt + sft
bt debt-to-GDP ratio,
it average nominal (effective) interest rate
gt nominal GDP growth rate
pbt is the primary balance-to-GDP
sft is the stock-flow adjustment-to-GDP ratio
gt can be decomposed into a real and a price
(deflator) part
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
6
Fiscal consolidation
Inflation and public debt reduction
Standard
decomposition
of debt changes:
- Budget balance
- Real GDP
- GDP deflator
- Def.-debt adj.
Departamento de Coyuntura y
Previsión Económica
DETERMINANTS OF THE CHANGE OF PUBLIC DEBT IN SPAIN: FISCAL CONSOLIDATION EPISODES OF THE 1990s AND CURRENT
-10
0
10
20
30
40
50
60
2009 2010 2011 2012 2013 2014
BALANCE GDP DEFLATOR RATE OF CHANGE REAL GDP RATE OF CHANGE DEFICIT-DEBT ADJUSTMENT CHANGE IN DEBT
LOW INFLATION EPISODE, CUMMULATED IMPACT
% OF GDP
-30
-20
-10
0
10
20
30
40
1993 1994 1995 1996 1997 1998
HIGH INFLATION EPISODE, CUMMULATED IMPACT
% OF GDP
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
7
Fiscal consolidation
Inflation and public revenues
Limits to tax
collection
despite “real”
recovery (2014)
- VAT “trend” base
(private consumption,
residential investment,
intermediate consumption,
public investment, tourism)
decomposition into
real and “price” parts
Departamento de Coyuntura y
Previsión Económica
D log(VATt)= e x Baset + Measurest + ut
VATt : VAT collection
Baset : proxy to tax base using macro variables
Measurest : discretionary policy measures
ut : adjustments
Baset is nominal: it can be decomposed into
a real and a price (deflator) part
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
8
Fiscal consolidation
Inflation and public revenues
Limits to tax
collection
despite “real”
recovery (2014)
- VAT “trend” base
(private consumption,
residential investment,
intermediate consumption,
public investment, tourism)
decomposition into
real and “price” parts
Departamento de Coyuntura y
Previsión Económica
-8
-6
-4
-2
0
2
4
6
8
10
12
Real component Price component Nominal trend VAT base
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
9
Fiscal consolidation
Inflation and public spending
Limits to savings from
“austerity” measures:
- Example: sequence of wage
cuts/freezes over 2010-2014
Estimated public spending
savings (wages and salaries):
measures vs November CPI +
savings wrt 2% inflation
(direct, ex ante effects)
Departamento de Coyuntura y
Previsión Económica
-16
-14
-12
-10
-8
-6
-4
-2
0
2010 2011 2012 2013 2014
Estimated savings in bln. euro (cummulative)
Saving with 2% inflation in bln. euro (cummulative)
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
10
Inflation shocks
Inflation shock
The source of the “inflation shock”is key
Oil price shock (10% reduction)
Margin shock (-1pp CPI non energy)
MTBE model – simulate response of
Private consumption deflator / Compensation per employee.
Real GDP / Real private consumption / Real private investment
Direct taxes to households (wages) / Indirect taxes / Public spending
Public deficit / Public debt
Public spending does not react but for: interest, U, other transfers Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
11
Inflation shocks
Inflation shock [temporary]: oil prices (10% reduction)
cummulative level differences
Response of:
Priv. cons. deflator
Comp. per empl.
Real GDP
Real priv. cons.
Real priv. invest.
Direct taxes hous.
Indirect taxes
Public spending
Public deficit
Public debtDepartamento de Coyuntura y
Previsión Económica
-0,50
-0,40
-0,30
-0,20
-0,10
0,00
2014 2015 2016
Private cons. Deflator Compensation per employee
0,00
0,10
0,20
0,30
0,40
0,50
2014 2015 2016
Real GDP Private prod. Inv. Real private cons.
-0,40
-0,20
0,00
0,20
0,40
2014 2015 2016
Direct taxes to households Indirect taxes
Public spending
-0,50
-0,40
-0,30
-0,20
-0,10
0,00
0,10
0,20
2014 2015 2016
Public debt (%GDP) Budget balance (%GDP)
NOMBRE DEL DEPARTAMENTO
Inflation shock [temp]: margin shock (-1pp CPI non energy)
cummulative level differences
Response of:
Priv. cons. deflator
Comp. per empl.
Real GDP
Real priv. cons.
Real priv. invest.
Direct taxes hous.
Indirect taxes
Public spending
Public deficit
Public debt
Public finances and inflation: the case of Spain
12
Inflation shocks
Departamento de Coyuntura y
Previsión Económica
-1,00
-0,80
-0,60
-0,40
-0,20
0,00
2014 2015 2016
Private cons. Deflator Compensation per employee
0,00
0,20
0,40
0,60
0,80
1,00
1,20
2014 2015 2016
Real GDP Private prod. Inv. Real private cons.
-1,00
-0,50
0,00
2014 2015 2016
Direct taxes to households Indirect taxes
Public spending
-0,20
0,00
0,20
0,40
0,60
0,80
2014 2015 2016
Public debt (%GDP) Budget balance (%GDP)
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
13
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
Ageing 2012 report: increase in pension spending expected
for ES as
a % GDP,
due to
adverse
demography
Departamento de Coyuntura y
Previsión Económica
10,0
10,5
11,0
11,5
12,0
12,5
13,0
13,5
14,0
14,5
Pension System Scenario 2012 Ageing Report(% of GDP)
Public pensions expenditure
Income from contributions
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
14
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
Reforms in 2011 and 2013. The 2013 one includes a
sustainability factor and a revaluation index
The revaluation index: The minimum and maximum
annual revaluation levels were set at 0.25% and the CPI
plus 0.5% respectively.
Pensions would grow above 0.25% only when the Social
Security System is, broadly speaking, in surplus (in
structural terms), and in line with fundamentalsDepartamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
15
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
Departamento de Coyuntura y
Previsión Económica
ASSUMPTIONS OF ACCOUNTING PROJECTIONRates of Change (%) Average
2014 2020 2030 2040 2050 2010 - 2051
Real GDP 0,9 2,4 2,2 1,1 1,2 1,5
debido a:Inflation 0,6 2,0 2,0 2,0 2,0 2,0
- Tasa de variación de ingresosRevenues of the System -0,1 4,4 4,2 3,1 3,2 3,4
- Tasa de variación número de pensionistasNumber of Pensions 1,4 1,4 2,9 2,8 0,9 2,0Source: Bank of Spain and 2012 Ageing Report.
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
16
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
Departamento de Coyuntura y
Previsión Económica
-5
-4
-3
-2
-1
0
1
2
3
4
5
2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050
Average Pension Rate of Change after Sustainability Factor(rate of change and p.p.)
Ceiling - floor clauses Correction of system imbalancesSubstitution effect rate of change Number of pensions rate of changeRevenues rate of change Average pension rate of change under reformAverage pension rate of change 2012 Ageing Report
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
17
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
Departamento de Coyuntura y
Previsión Económica-6
-5
-4
-3
-2
-1
0
1
2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2053
Decomposition of Savings due to Reform(% of GDP)
Sustainability factor
Increase in avrg. pension benefits
Total savings in expenditure due to reform
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
18
Medium-term effects
Permanent low inflation and effectiveness of pension
reform (“revaluation index”)
“Savings” (pension expenditure) depend crucially on
inflation assumptions
Sanchez (2014, BE WP – OLG model): “Our simulation
indicates that a persistently low inflation could be (in the long
term) as harmful for the success of the reform as poor
immigration and productivity.”
Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
19
Summary
Implications of a low inflation environment for…
Fiscal consolidation (some accounting examples)
PUBLIC DEBT: The consolidation episode of the 1990s vs now
PUBLIC SPENDING: impact of measures in a low-inflation framework
PUBLIC REVENUE: limits to tax collection
Some simulations using Bank of Spain’s MTBE
INFLATION SHOCKS: inspecting the channels - oil prices, profit margins
Medium-term fiscal sustainability safeguards
PENSION SUSTAINABILITY: the “revaluation index”
Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO 20
THANKS FOR YOUR ATTENTION
Public finances and inflation:
the case of Spain
Javier J. Pérez (Banco de España)
Joint work with S. Hurtado, F. Martí, and P. Hernández
Departamento de Coyuntura y
Previsión Económica
NOMBRE DEL DEPARTAMENTO
Public finances and inflation: the case of Spain
21Departamento de Coyuntura y
Previsión Económica
PUBLIC AND PRIVATE CONSUMPTION DEFLATORS
-5
0
5
10
15
20
25
1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
BASE86 PRIVATE BASE86 PUBLIC ESA2010 PRIVATE ESA2010 PUBLIC
% CHANGE