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Social Security and the Interactions Between Aggregate and Idiosyncratic Risk

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Listed author(s):
  • Daniel Harenberg
  • Alexander Ludwig

Abstract

We ask whether a PAYG-financed social security system is welfare improving in an economy with idiosyncratic and aggregate risk. We argue that interactions between the two risks are important for this question. One is a direct interaction in the form of a countercyclical variance of idiosyncratic income risk. The other indirectly emerges over a household's life-cycle because retirement savings contain the history of idiosyncratic and aggregate shocks. We show that this leads to risk interactions, even when risks are statistically independent. In our quantitative analysis, we find that introducing social security with a contribution rate of two percent leads to welfare gains of 2.2% of lifetime consumption in expectation, despite substantial crowding out of capital. This welfare gain stands in contrast to the welfare losses documented in the previous literature, which studies one risk in isolation. We show that jointly modeling both risks is crucial: 60% of the welfare benefits from insurance result from the interactions of risks.

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Paper provided by University of Cologne, Department of Economics in its series Working Paper Series in Economics with number 71.

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Date of creation: 20 Mar 2014
Handle: RePEc:kls:series:0071
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Keywords: social security; idiosyncratic risk; aggregate risk; welfare;

Other versions of this item:

Find related papers by JEL classification:
  • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
  • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
  • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
  • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Social Security and the Interactions Between Aggregate and Idiosyncratic Risk
    by Christian Zimmermann in NEP-DGE blog on 2014-04-09 02:38:42
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Cited by:

  1. Daniel Harenberg & Alexander Ludwig, 2015. "Social security in an analytically tractable overlapping generations model with aggregate and idiosyncratic risks," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(4), pages 579-603, August.
  2. Xu, Shaofeng, 2016. "On the welfare cost of rare housing disasters," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 301-318.

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