On Pessimism and Optimism by Forward Looking Agents and the Need for Social Security

Abstract

We study whether pessimism and optimism about the future by forward looking agents provides a rationale for social security. We first distinguish between an agent’s true and pessimistic preferences and then analyze whether this agent’s level of saving depends on the pessimism parameter ( π ) and how welfare measured by the agent’s true preferences depends on π . Next, we examine whether it is possible for pessimism to increase the agent’s true utility and then show that this kind of pessimism does not provide a rationale for social security. Moving on to optimism, we study the need for a pay-as-you-go (PAYG) social security system when the agent is optimistic about the generosity of the PAYG system. This optimism is modeled with a parameter ( ω ). In this setting, we first study the impact that an increase in ω has on the agent’s saving and then examine whether this agent’s welfare increases or decreases in ω . Finally, we show that this kind of optimism does not justify the presence of the PAYG social security system.