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Political Intergenerational Risk Sharing

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Abstract

TIn a stochastic two-period OLG model, featuring an aggregate shock to the economy, ex-ante optimality requires intergenerational risk sharing. We compare the level of time-consistent intergenerational risk sharing chosen by a benevolent government and by an office-seeking politician. In our political system, the transfer of resources across generations is determined as a Markov equilibrium of a probabilistic voting game. Low realized returns on the risky asset induce politicians to compensate the old through a PAYG system. This political system typically generates an intergenerational risk sharing scheme that is (i) larger, (ii) more persistent, and (iii) less responsive to the realization of the shock than the (time consistent) social optimum. This is because the current politician anticipates her transfers to the elderly to be compensated by future politicians through offsetting transfers, and hence overspends. Aging increases the optimal transfer, but surprisingly makes office-seeking politicians more conservative, by increasing the cost for future politicians to compensate the current young.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 216.

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Date of creation: 06 Mar 2009
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Handle: RePEc:sef:csefwp:216

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Keywords: Pension Systems; Markov equilibria; social optimum;

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Cited by:
  1. Ryo Arawatari & Tetsuo Ono, 2008. "A Political Economy Model of Earnings Mobility and Redistribution Policy," Discussion Papers in Economics and Business 08-18-Rev.3, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP), revised Aug 2011.
  2. Oguro, Kazumasa & Ishida, Ryo, 2012. "The Viability of a Voting System that Allocates Parliamentary Seats According to Life Expectancy: An analysis using OLG models," CIS Discussion paper series 571, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
  3. Hollanders, D.A., 2010. "The Political Economy of Intergenerational Risk Sharing," Discussion Paper 2010-102, Tilburg University, Center for Economic Research.
  4. Corsini, Lorenzo & Spataro, Luca, 2011. "Optimal decisions on pension plans in the presence of financial literacy costs and income inequalities," MPRA Paper 30946, University Library of Munich, Germany.
  5. Ed Westerhout, 2011. "Intergenerational Risk Sharing in Time-Consistent Funded Pension Schemes," CPB Discussion Paper 176, CPB Netherlands Bureau for Economic Policy Analysis.
  6. Ryo Arawatari & Tetsuo Ono, 2011. "A Political Economy Theory of Government Debt and Social Security," Discussion Papers in Economics and Business 11-33, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).

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