Political Intergenerational Risk Sharing

34 Pages Posted: 2 Dec 2008

See all articles by Marcello D'Amato

Marcello D'Amato

Centre of Labour Economics and Economic Policy (CELPE)

Vincenzo Galasso

University of Lugano; Centre for Economic Policy Research (CEPR)

Date Written: September 2008

Abstract

In a stochastic two-period OLG model, featuring an aggregate shock to the economy, ex-ante optimality requires intergenerational risk sharing. We compare the level of time-consistent intergenerational risk sharing chosen by a social planner and by office seeking politicians. In the political setting, the transfer of resources across generations - a PAYG pension system - is determined as a Markov equilibrium of a probabilistic voting game. Negative shocks represented by low realized returns on the risky asset induce politicians to compensate the old through a PAYG system. Unless the young are crucial to win the election, this political system generates more intergenerational risk sharing than the (time consistent) social optimum. In particular, these transfers are more persistent and less responsive to the realization of the shock than optimal. This is because politicians anticipate their current transfers to the elderly to be compensated through offsetting transfers by future politicians, and thus have an incentive to overspend. Perhaps surprisingly, aging increases the socially optimal transfer but makes politicians less likely to overspend, by making it more costly for future politicians to compensate the current young.

Keywords: Markov equilibria, Pension Systems, social optimum

JEL Classification: D72, H55

Suggested Citation

D'Amato, Marcello and Galasso, Vincenzo, Political Intergenerational Risk Sharing (September 2008). CEPR Discussion Paper No. DP6972. Available at SSRN: https://ssrn.com/abstract=1308043

Marcello D'Amato

Centre of Labour Economics and Economic Policy (CELPE) ( email )

Università di Salerno
Via ponte don Melillo
Fisciano, SA 84084
Italy

Vincenzo Galasso (Contact Author)

University of Lugano ( email )

Via Giuseppe Buffi 13
Lugano, 6900
Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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