On the inefficiency of pay-as-you-go pension systems in stochastic economies with assets

This paper studies the impact of variations of a pay-as-you-go pension system on welfare in a stochastic overlapping generations model where compulsory public retirement savings coexist with private savings in assets and bonds. It is shown that, for a stationary population, any reduction of contribution rates once and for all leads to a long-run welfare improvement of consumers. Moreover, a gradual reduction of contribution rates induces a smooth transition towards a purely privately generated retirement system keeping the welfare losses of current retirees sufficiently small. An unfavorable demographic change, modelled as a transitory phenomenon toward increased ageing of the population, is shown to induce significant welfare losses. The paper discusses several possible adjustment policies. It is shown that in general an adjustment of contribution rates cannot alleviate but may even amplify the welfare loss. The most promising political measure is shown to be a temporary increase in the retirement age.