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Social Security Reform with Uninsurable Income Risk and Endogenous Borrowing Constraints

  • Juan A. Rojas

    ()

    (Universidad Carlos III de Madrid)

  • Carlos Urrutia

    ()

    (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

We study the aggregate effects of a social security reform in a large overlapping generations model where markets are incomplete and households face uninsurable idiosyncratic income shocks. We depart from the previous literature by assuming that, because of lack of commitment in the credit market, the borrowing constraint in the unique asset is endogenously determined by the agents' incentives to default on previous debts. We find that a model with exogenous borrowing constraints overestimates the positive effect of reforming social security on the capital stock and the saving rate, compared to our model with endogenous borrowing limit. The reason is that, in the latter, the size of precautionary savings is smaller because after the reform the incentives to default on previous debts are lower and consequently households face more relaxed borrowing limits. Adding retirement accounts to the basic model does not change these conclusions, although the quantitative importance of endogenizing borrowing constraints is reduced.

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File URL: http://ftp.itam.mx/pub/academico/inves/urrutia/04-09.pdf
File Function: First version, 2004
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Paper provided by Centro de Investigacion Economica, ITAM in its series Working Papers with number 0409.

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Length: 31 pages
Date of creation: Oct 2004
Date of revision:
Handle: RePEc:cie:wpaper:0409
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