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Global Aging and Declining World Interest Rates: Macroeconomic Insurance Through Pension Reform in Cyprus

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Author Info
Mario Catalán
Jaime Guajardo
Alexander W. Hoffmaister

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Abstract

How will the world-wide decline in real interest rates associated with global aging affect small open economies (SOEs) with aging populations? Lower interest rates will result in higher capital-labor ratios and increased wages; higher wages, in turn, will be passed on to pension benefits, exacerbating aging-related fiscal pressures. The pass-through effect will be stronger if pensions are indexed to nominal wages rather than prices. Using an overlapping generations model, the paper illustrates the interest rates transmission mechanism and its interaction with pension indexation for the case of Cyprus. In addition, the paper evaluates the capacity of pension reforms to insure the economy against long-run movements in world interest rates. It concludes that pension reforms, particularly those that change the indexation of pensions from wages to prices, provide substantial macro-insurance and shock absorption benefits.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/98.

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Length: 40 pages
Date of creation: 24 Apr 2008
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Handle: RePEc:imf:imfwpa:08/98

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  1. Alexander Ludwig & Dirk Krüger, 2006. "On the Consequences of Demographic Change for Rates of Returns to Capital, and the Distribution of Wealth and Welfare," MEA discussion paper series 06103, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
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  2. Stéphanie Guichard & Willi Leibfritz, 2006. "The Fiscal Challenge in Portugal," OECD Economics Department Working Papers 489, OECD, Economics Department. [Downloadable!]
  3. Laurence J. Kotlikoff, 1998. "The A-K Model: It's Past, Present, and Future," NBER Working Papers 6684, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Hoffmaister, Alexander W. & Roldos, Jorge E., 2001. "The Sources of Macroeconomic Fluctuations in Developing Countries: Brazil and Korea," Journal of Macroeconomics, Elsevier, vol. 23(2), pages 213-239, April. [Downloadable!] (restricted)
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  5. David Domeij & Martin Flodén, 2006. "Population Aging And International Capital Flows," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 1013-1032, 08. [Downloadable!] (restricted)
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