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Sharing Demographic Risk – Who is Afraid of the Baby Bust?

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Author Info
Alexander Ludwig ()
Michael Reiter ()

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Abstract

We model the optimal reaction of a public PAYG pension system to demographic shocks. We compare the ex-ante first best and second best solution of a Ramsey planner with full commitment to the outcome under simple third best rules that mimic the pension systems observed in the real world. The model, in particular the pension system, is calibrated to the German economy. The objective of the social planner is calibrated such that the size of the German pension system was optimal under the economic and demographic conditions of the 1960s. We find that the German system comes relatively close to the second-best solution, especially when labor market distortions are correctly modelled. Furthermore, the German system and a constant contribution rate lead to a lower variability of lifetime utility than does the second best policy. The recent baby-boom/baby-bust cycle leads to welfare losses of about 5% of lifetime consumption for some cohorts. We argue that it is crucial for these results to model correctly the labor market distortions arising from the pension system.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 2422.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2422

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Related research
Keywords: social security; pension design; optimal fiscal policy; demographic uncertainty;

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Find related papers by JEL classification:
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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  1. Krueger, Dirk & Ludwig, Alexander, 2007. "On the consequences of demographic change for rates of returns to capital, and the distribution of wealth and welfare," Journal of Monetary Economics, Elsevier, vol. 54(1), pages 49-87, January. [Downloadable!] (restricted)
    Other versions:
  2. Emmanuel Farhi & Ivan Werning, 2006. "Progressive Estate Taxation," NBER Working Papers 12600, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Erosa, Andres & Gervais, Martin, 2002. "Optimal Taxation in Life-Cycle Economies," Journal of Economic Theory, Elsevier, vol. 105(2), pages 338-369, August. [Downloadable!] (restricted)
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  5. Gordon, Roger H. & Varian, Hal R., 1988. "Intergenerational risk sharing," Journal of Public Economics, Elsevier, vol. 37(2), pages 185-202, November. [Downloadable!] (restricted)
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  6. Sanchez-Marcos, Virginia & Sanchez-Martin, Alfonso R., 2006. "Can social security be welfare improving when there is demographic uncertainty?," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1615-1646. [Downloadable!] (restricted)
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  7. Bernheim, B Douglas, 1989. "Intergenerational Altruism, Dynastic Equilibria and Social Welfare," Review of Economic Studies, Blackwell Publishing, vol. 56(1), pages 119-28, January. [Downloadable!] (restricted)
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  12. Henning Bohn, 1999. "Social Security and Demographic Uncertainty: The Risk Sharing Properties of Alternative Policies," NBER Working Papers 7030, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Demange, G., 2000. "On Optimality of Intergenerational Risk Sharing," DELTA Working Papers 2000-05, DELTA (Ecole normale supérieure).
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  15. Dirk Krueger & Felix Kubler, 2006. "Pareto-Improving Social Security Reform when Financial Markets are Incomplete!?," American Economic Review, American Economic Association, vol. 96(3), pages 737-755, June. [Downloadable!]
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  16. Benigno, Pierpaolo & Woodford, Michael, 2004. "Optimal Taxation in an RBC Model: A Linear-Quadratic Approach," CEPR Discussion Papers 4764, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  17. Debortoli, Davide & Nunes, Ricardo, 2006. "On Linear Quadratic Approximations," MPRA Paper 544, University Library of Munich, Germany, revised Jul 2006. [Downloadable!]
  18. Alan J. Auerbach & Ronald Lee, 2009. "Welfare and Generational Equity in Sustainable Unfunded Pension Systems," NBER Working Papers 14682, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Andrew Glyn & Dean Baker & David Howell & John Schmitt, 2003. "Labor Market Institutions and Unemployment: A Critical Assessment of the Cross-Country Evidence," Economics Series Working Papers 168, University of Oxford, Department of Economics. [Downloadable!]
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  20. William D. Nordhaus, 2006. "The "Stern Review" on the Economics of Climate Change," NBER Working Papers 12741, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  21. Martín Gonzalez-Eiras & Dirk Niepelt, 2005. "Sustaining Social Security," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  22. Andrew Caplin & John Leahy, 2004. "The Social Discount Rate," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1257-1268, December.
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  23. Piero Gottardi & Felix Kubler, 2006. "Social Security and Risk Sharing," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
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