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Pension financing and macroeconomic equilibrium

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  • Enrico D’Elia

    (ISAE - Institute for Studies and Economic Analyses)

Abstract

Financing pension systems necessitates that actual output is redistributed from workers and entrepreneurs actually in activity in favour of retirees. Therefore, in a closed economy, the return on accrued pension funds, to be distributed to pensioners, is ceiled by the real growth of income, unless the share of income levied on active workers increases indefinitely. Only possible revenues from past foreign investment can increase the overall resources available to pay domestic pensions. Thus, an efficient pre funded pension system inevitably stimulates large international capital movements. The paper sheds some light on an issue often overlooked in the debate on the merits and drawbacks of different systems, i.e. their possible consequences on interest and exchange rates. In order to provide an explicit solution for the dynamics of the relevant variables, the paper adopts an analytical approach more simple than the usual overlapping generation models. In particular, the paper confirms that in an aging society, with a fully indexed PAYG system, a constant contribution rate would make the public debt and related interest rates explode. On the other hand, in a pre-funded system, interest rates should be set below the national growth rates, and exchange rates must be ready to accommodate to large deficit of the balance of payment for many decades after the switch from a PAYG system, and later to large surplus.

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Bibliographic Info

Paper provided by ISTAT - Italian National Institute of Statistics - (Rome, ITALY) in its series ISAE Working Papers with number 128.

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Length: 18 pages
Date of creation: Jul 2010
Date of revision:
Handle: RePEc:isa:wpaper:128

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Keywords: Aging society; Capital movements; Monetary policy; Pensions;

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