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How Does Pension Reform Affect Savings and Welfare

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  • Rodrigo Cifuentes

Abstract

This paper explores the effects of pension reform on precautionary savings, wealth accumulation and welfare. The impact of pension programs on income uncertainty through life has been largely ignored in the literature of precautionary savings and pension reform. This paper uses dynamic programming techniques to solve for the optimal consumption of a worker that faces uncertainty on labor and retirement income. Subsequently, with parameter values for the U.S., I study the impact of two policies on workers with different on educational levels. One is the elimination of redistribution in the current benefits formula. The second is the change from system defined in benefits (DB) to one defined in contributions (DC). In the first case, results show that redistribution is valued positively by all types of agents, even by those who expect losses from it, given their expected income. As a consequence, workers increase their savings to prepare for the increased uncertainty. The increase in aggregate savings is in the order of 4%. The second case has the opposite consequences. Welfare increases with the adoption of the DC system because it has superior insurance properties. The advantage consists in that periods on which the variance of income is lower receive a higher weight in the calculation of benefits. Precautionary savings are reduced with a fall in aggregate savings of 1.4%.

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  • Rodrigo Cifuentes, 2000. "How Does Pension Reform Affect Savings and Welfare," Working Papers Central Bank of Chile 80, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:80
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    References listed on IDEAS

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    1. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
    2. Antonio Rangel & Richard Zeckhauser, 2001. "Can Market and Voting Institutions Generate Optimal Intergenerational Risk Sharing?," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 113-152 National Bureau of Economic Research, Inc.
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    4. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-467, June.
    5. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467-467.
    6. Stephen P. Zeldes, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 275-298.
    7. Martin Feldstein & Andrew Samwick, 1997. "The Economics of Prefunding Social Security and Medicare Benefits," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 115-164 National Bureau of Economic Research, Inc.
    8. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
    9. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244.
    10. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, vol. 8(3), pages 275-298, December.
    11. Samwick, Andrew A., 1998. "Discount rate heterogeneity and social security reform," Journal of Development Economics, Elsevier, vol. 57(1), pages 117-146, October.
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    Cited by:

    1. Rodrigo Cerda, 2006. "Pensiones en Chile: ¿Qué Hubiese Ocurrido sin la Reforma de 1981?," Documentos de Trabajo 310, Instituto de Economia. Pontificia Universidad Católica de Chile..
    2. Cerda, Rodrigo A., 2008. "Social Security and Wealth Accumulation in Developing Economies: Evidence from the 1981 Chilean Reform," World Development, Elsevier, vol. 36(10), pages 2029-2044, October.

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