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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 reaction of a 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. The model is calibrated to the German economy. We find that the German system comes relatively close to the second-best solution, and that the recent baby-boom/baby-bust cycle leads to welfare losses of about 5 percent of lifetime consumption for some cohorts. We argue that it is crucial for all our results to correctly model the labor market distortions arising from the pension system. (JEL D91, E62, H55, J11)

Suggested Citation

  • Alexander Ludwig & Michael Reiter, 2010. "Sharing Demographic Risk--Who Is Afraid of the Baby Bust?," American Economic Journal: Economic Policy, American Economic Association, vol. 2(4), pages 83-118, November.
    • Handle: RePEc:aea:aejpol:v:2:y:2010:i:4:p:83-118
    Note: DOI: 10.1257/pol.2.4.83
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    Cited by:

    1. Sánchez-Romero, Miguel & Sambt, Jože & Prskawetz, Alexia, 2013. "Quantifying the role of alternative pension reforms on the Austrian economy," Labour Economics, Elsevier, vol. 22(C), pages 94-114.
    2. Schön, Matthias, 2020. "Demographic change and the rate of return in PAYG pension systems," Discussion Papers 57/2020, Deutsche Bundesbank.
    3. Auerbach, Alan & Kueng, Lorenz & Lee, Ronald & Yatsynovich, Yury, 2018. "Propagation and smoothing of shocks in alternative social security systems," Journal of Public Economics, Elsevier, vol. 164(C), pages 91-105.
    4. Daniel Harenberg & Alexander Ludwig, "undated". "Social Security and the Interactions Between Aggregate and Idiosyncratic Risk," Working Papers ETH-RC-14-002, ETH Zurich, Chair of Systems Design.
    5. Michael Reiter, 2015. "Solving OLG Models with Asset Choice," 2015 Meeting Papers 1509, Society for Economic Dynamics.
    6. Krzysztof Makarski & Joanna Tyrowicz & Magda Malec, 2018. "Evaluating welfare and economic effects of raised fertility," GRAPE Working Papers 25, GRAPE Group for Research in Applied Economics.
    7. Busch, Christopher & Krueger, Dirk & Ludwig, Alexander & Popova, Irina & Iftikhar, Zainab, 2020. "Should Germany have built a new wall? Macroeconomic lessons from the 2015-18 refugee wave," Journal of Monetary Economics, Elsevier, vol. 113(C), pages 28-55.
    8. Volker Grossmann & Johannes Schünemann & Holger Strulik, 2021. "Fair Pension Policies with Occupation-Specific Aging," CESifo Working Paper Series 9180, CESifo.
    9. Anna Batyra & David de la Croix & Olivier Pierrard & Henri Sneessens, 2016. "Structural changes in the labor market and the rise of early retirement in Europe," DEM Discussion Paper Series 16-13, Department of Economics at the University of Luxembourg.
    10. Gabay, Daniel & Grasselli, Martino, 2012. "Fair demographic risk sharing in defined contribution pension systems," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 657-669.
    11. Daniel Harenberg & Alexander Ludwig, 2015. "Social security in an analytically tractable overlapping generations model with aggregate and idiosyncratic risks," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(4), pages 579-603, August.
    12. Miguel Sánchez-Romero, 2013. "The role of demography on per capita output growth and saving rates," Journal of Population Economics, Springer;European Society for Population Economics, vol. 26(4), pages 1347-1377, October.
    13. Daniel Harenberg & Alexander Ludwig, 2019. "Idiosyncratic Risk, Aggregate Risk, And The Welfare Effects Of Social Security," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 60(2), pages 661-692, May.
    14. Schön, Matthias, 2019. "Demographic change and the German current account surplus," VfS Annual Conference 2019 (Leipzig): 30 Years after the Fall of the Berlin Wall - Democracy and Market Economy 203527, Verein für Socialpolitik / German Economic Association.
    15. Krzysztof Makarski & Joanna Tyrowicz & Magda Malec, 2019. "Fiscal and Welfare Effects of Raised Fertility in Poland: Overlapping Generations Model Estimates," Population and Development Review, The Population Council, Inc., vol. 45(4), pages 795-818, December.
    16. Auerbach, Alan J. & Lee, Ronald, 2011. "Welfare and generational equity in sustainable unfunded pension systems," Journal of Public Economics, Elsevier, vol. 95(1-2), pages 16-27, February.
    17. Alfonso R. Sánchez, 2014. "The automatic adjustment of pension expenditures in Spain:an evaluation of the 2013 pension reform," Working Papers 1420, Banco de España.
    18. Davoine, Thomas, 2022. "Cross-country differences in the long-run economic impacts of increased fertility," IHS Working Paper Series 38, Institute for Advanced Studies.
    19. Schön, Matthias, 2020. "Long-term outlook for the German statutory pension system," Discussion Papers 22/2020, Deutsche Bundesbank.
    20. Wolfgang Kuhle, 2014. "The Optimal Structure for Public Debt," Metroeconomica, Wiley Blackwell, vol. 65(2), pages 321-348, May.
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    22. Reiter, Michael, 2015. "Solving OLG Models with Many Cohorts, Asset Choice and Large Shocks," Economics Series 320, Institute for Advanced Studies.
    23. Sánchez-Romero, Miguel & Prskawetz, Alexia, 2017. "Redistributive effects of the US pension system among individuals with different life expectancy," The Journal of the Economics of Ageing, Elsevier, vol. 10(C), pages 51-74.
    24. Knell, Markus, 2013. "The Intergenerational Distribution of Demographic Fluctuations in Unfunded and Funded Pension Systems," VfS Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79830, Verein für Socialpolitik / German Economic Association.

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    More about this item

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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