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

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Author Info
Alexander Ludwig ()
Michael Reiter () (Mannheim Research Institute for the Economics of Aging (MEA))

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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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Paper provided by Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim in its series MEA discussion paper series with number 08166.

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Date of creation: 30 Oct 2008
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Handle: RePEc:mea:meawpa:08166

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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
H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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