The impact of early pension withdrawals on household finances and inflation

This paper exploits Estonia's 2021 pension reform to examine the impact of a large-scale liquidity shock on household finances and inflation. The reform made the second-pillar pension contributions voluntary and allowed early withdrawals before retirement age. One-fifth of contributors withdrew their pension savings as soon as this option became available. Individual-level data from the Household Finance and Consumption Survey are used to reveal the balance-sheet and behavioural characteristics of leavers. Aggregate National Accounts and Distributional Wealth Accounts data, and the synthetic differences-in-differences method are applied to assess how the money withdrawn was spent. The leavers had low liquidity, little experience of investing in risky financial assets, and a large outstanding balance of consumer credit, while their households were present-biased and had a high marginal propensity to consume. This profile fits the aggregate estimates on how the withdrawals were spent. A large part of the withdrawals was accumulated as deposits without being reinvested, a substantial fraction was used to pay back consumer debt, and the rest was spent on consumption. The elevated consumption contributed to a temporary hike in inflation. The paper highlights the short-term implications of pension-asset liquidations; further studies are warranted on the longer-run implications.