Social Security Reform with Uninsurable Income Risk and Endogenous Borrowing Constraints

46 Pages Posted: 8 May 2006

See all articles by Carlos Urrutia

Carlos Urrutia

Instituto Tecnológico Autónomo de México (ITAM) - Centro de Investigacion Economica

Juan Rojas

European Stability Mechanism

Date Written: February 9, 2006

Abstract

We study the aggregate effects of a social security reform in a large overlapping generations model where markets are incomplete and households face uninsurable idiosyncratic income shocks. We depart from the previous literature by assuming that, because of lack of commitment in the credit market, the borrowing constraint in the unique asset is endogenously determined by the agents' incentives to default on previous debts. We find that a model with fixed borrowing constraints overestimates the positive effect of reforming social security on the capital stock and the saving rate, compared to our model with endogenous borrowing limit. The reason is that, in the latter, the size of precautionary savings is smaller because after the reform the incentives to default on previous debts are lower and consequently households face more relaxed borrowing limits. Adding retirement accounts to the basic model does not change these conclusions, although the quantitative importance of endogenizing borrowing constraints is reduced.

Keywords: Social security, Borrowing constraints, retirement accounts

JEL Classification: E6, G23, H55

Suggested Citation

Urrutia, Carlos and Rojas, Juan, Social Security Reform with Uninsurable Income Risk and Endogenous Borrowing Constraints (February 9, 2006). Banco de Espana Research Paper No. WP-0602, Available at SSRN: https://ssrn.com/abstract=900807 or http://dx.doi.org/10.2139/ssrn.900807

Carlos Urrutia

Instituto Tecnológico Autónomo de México (ITAM) - Centro de Investigacion Economica ( email )

Av. Camino a Santa Teresa #930
Col. Heroes de Padierna
Mexico City, D.F. 10370
Mexico

Juan Rojas (Contact Author)

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

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