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Global Aging and Declining World Interest Rates; Macroeconomic Insurance Through Pension Reform in Cyprus

  • Alexander W. Hoffmaister
  • Jaime Guajardo
  • Mario Catalán

How will the world-wide decline in real interest rates associated with global aging affect small open economies (SOEs) with aging populations? Lower interest rates will result in higher capital-labor ratios and increased wages; higher wages, in turn, will be passed on to pension benefits, exacerbating aging-related fiscal pressures. The pass-through effect will be stronger if pensions are indexed to nominal wages rather than prices. Using an overlapping generations model, the paper illustrates the interest rates transmission mechanism and its interaction with pension indexation for the case of Cyprus. In addition, the paper evaluates the capacity of pension reforms to insure the economy against long-run movements in world interest rates. It concludes that pension reforms, particularly those that change the indexation of pensions from wages to prices, provide substantial macro-insurance and shock absorption benefits.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/98.

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Length: 40
Date of creation: 01 Apr 2008
Date of revision:
Handle: RePEc:imf:imfwpa:08/98
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  1. Laurence J. Kotlikoff, 1998. "The A-K Model: It's Past, Present, and Future," NBER Working Papers 6684, National Bureau of Economic Research, Inc.
  2. Domeij, David & Flodén, Martin, 2003. "Population Aging and International Capital Flows," SSE/EFI Working Paper Series in Economics and Finance 539, Stockholm School of Economics, revised 21 Oct 2003.
  3. Krueger, Dirk & Ludwig, Alexander, 2007. "On the consequences of demographic change for rates of returns to capital, and the distribution of wealth and welfare," Journal of Monetary Economics, Elsevier, vol. 54(1), pages 49-87, January.
  4. David Weil, 2006. "Population Aging," Working Papers 2006-09, Brown University, Department of Economics.
  5. Alexander W. Hoffmaister & Mario Catalan & Jaime Guajardo, 2007. "Addressing the Macroeconomic Consequences of Aging in Cyprus: The Case for Pension Reform," Cyprus Economic Policy Review, University of Cyprus, Economics Research Centre, vol. 1(1), pages 3-25, June.
  6. Stéphanie Guichard & Willi Leibfritz, 2006. "The Fiscal Challenge in Portugal," OECD Economics Department Working Papers 489, OECD Publishing.
  7. Hoffmaister, Alexander W. & Roldos, Jorge E., 2001. "The Sources of Macroeconomic Fluctuations in Developing Countries: Brazil and Korea," Journal of Macroeconomics, Elsevier, vol. 23(2), pages 213-239, April.
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