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

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  • Alexander Ludwig
  • Michael Reiter

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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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2422.

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

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

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Citations

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Cited by:
  1. Daniel Harenberg & Alexander Ludwig, 2014. "Social Security and the Interactions Between Aggregate and Idiosyncratic Risk," CER-ETH Economics working paper series 14/193, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  2. Knell, Markus, 2013. "The Intergenerational Distribution of Demographic Fluctuations in Unfunded and Funded Pension Systems," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79830, Verein für Socialpolitik / German Economic Association.
  3. Harenberg, Daniel & Ludwig, Alexander, 2014. "Social security and the interactions between aggregate and idiosyncratic risk," SAFE Working Paper Series 59, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  4. Miguel Sánchez-Romero, 2013. "The role of demography on per capita output growth and saving rates," Journal of Population Economics, Springer, Springer, vol. 26(4), pages 1347-1377, October.
  5. Sánchez-Romero, Miguel & Sambt, Jože & Prskawetz, Alexia, 2012. "Quantifying the role of alternative pension reforms on the Austrian economy," ECON WPS - Vienna University of Technology Working Papers in Economic Theory and Policy 04/2012, Vienna University of Technology, Institute for Mathematical Methods in Economics, Research Group Economics (ECON).
  6. 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.
  7. Alfonso R. Sánchez, 2014. "The automatic adjustment of pension expenditures in Spain:an evaluation of the 2013 pension reform," Banco de Espa�a Working Papers 1420, Banco de Espa�a.
  8. Gabay, Daniel & Grasselli, Martino, 2012. "Fair demographic risk sharing in defined contribution pension systems," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 36(4), pages 657-669.

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