CAN PAY-AS-YOU-GO PENSIONS RAISE THECAPITAL STOCK?

We reconsider pay-as-you-go pensions (PAYG) policy in a version of the Diamond(1965) overlapping generations model with an imperfectly competitive financialsector and with a low rate of tax on its profits. PAYG then has two effects on capital:the well-known negative crowding-out effect in displacing savings and a positiveeffect in reducing a second form of crowding-out caused by the displacement of"productive savings" in capital by "non-productive savings" in financial sector equity.These two countervailing effects may generate a hump-shaped steady-staterelationship between the PAYG contribution rate and the capital stock. If theoverriding goal of policy is to raise the level of economic activity, a radical overhaulof PAYG pensions may be ineffective or even counter-productive unless financialsector profits or dividends are taxed at a high rate. If this secondary policy isinfeasible, the scale of any proposed reform of PAYG should be measured against thedegree of competition in the financial sector.