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Reference-dependent preferences, time inconsistency, and unfunded pensions

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  • Andersen, Torben M.
  • Bhattacharya, Joydeep
  • Liu, Qing

Abstract

In the real world, public pay-as-you-go pension (PAYG) schemes are popular and co-exist with private, retirement-saving schemes. This is true even in dynamically efficient economies where such pensions offer a lower return. The classic Aaron- Samuelson result argues that, in theory, this is impossible. Later work has shown that it may be possible if agents, left on their own, undersave due to myopia or time-inconsistency. In that case, if the government is paternalistic, a welfare rationale for PAYG pensions arises but only if voluntary retirement saving is fully crowded out because of a binding borrowing constraint. This paper generalizes the Aaron- Samuelson discussion to the reference-dependent utility setup of K˝oszegi and Rabin (2009) where undersaving happens naturally. No borrowing constraint is imposed. In this case, it is possible to offer a non-paternalistic, welfare rationale for return dominated, PAYG pensions to coexist with private retirement saving.

Suggested Citation

  • Andersen, Torben M. & Bhattacharya, Joydeep & Liu, Qing, 2020. "Reference-dependent preferences, time inconsistency, and unfunded pensions," ISU General Staff Papers 202004170700001102, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:202004170700001102
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    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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