Macroeconomic Consequences of Social Security Uncertainty

second chapter of Erin’s prospectus/dissertation

Abstract:
Unfunded public pensions in many western nations are unsustainable as currently financed: promised future benefits exceed promised future taxation. Pension reform is inevitable, but uncertain. Governments may raise taxes, cut benefits, or take some action that combine changes to taxes and benefits. The timing and structure of pension reform is uncertain. A rational expectations, multi-period, overlapping generations model is developed to study the consequences of uncertain public pension reform. The pension system is modeled after the United States social security system. Policy uncertainty is modeled as a stochastic process with known underlying probability distributions. Agents in the model form rational expectations based on the distribution of policy outcomes. These beliefs determine the existence and nature of equilibrium. Expectations prior to a reform have large consequences for intergenerational consumption and on aggregate macroeconomic variables.

Key words: Policy Uncertainty, Social Security Reform, Retirement Savings, Overlapping Generations Model, Fiscal Sustainability, Bond-Financed Deficits