Journal Article

Pension systems and aggregate shocks

Abstract: The U.S. Social Security Trust Fund faces depletion over the coming decades, and there is a near consensus that social security reform is necessary. Under one suggestion for partial privatization, current surpluses would fund private, individual retirement accounts, and the private savings would make up for future benefit cuts. ; Moving away from social security, however, causes some people to point toward excessive risks associated with private savings. But social security cannot be completely riskless either because its long-term viability depends on such volatile factors as productivity growth, fertility, and immigration, which make social security risky for the same reasons financial assets are. ; To quantify the sensitivity of different retirement schemes to large aggregate shocks, this article provides a model economy in which aggregate shocks affect not only financial market returns but also a pay-as-you-go (PAYGO) pension system. The model depicts a life-cycle economy in which agents work when they are young and their old-age consumption is financed by a combination of a PAYGO pension system and private savings. ; The model simulations show that, in the long run, privatization makes every generation better off, even if a large aggregate shock occurs. The intuition for this result is that under a privatized pension system, savings are higher. This higher savings level increases the capital stock and thus increases welfare enough to insulate all future generations even from large shocks.

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: Economic Review

Publication Date: 2003

Volume: 88

Issue: Q1

Pages: 15-31