Abstract
AbstractIn this paper we reconsider the idea of an earnings-related pension system with reserves invested in indexed government bonds as a mechanism to both ensure financial sustainability and improve security. The paper starts by reviewing the characterization of the sustainable rate of return of an earnings-related pension system with pay-as-you-go financing. We show that current proxies for the sustainable rate, including the Swedish ‘gyroscope’, are not stable and propose an alternative measure that depends on the growth of the buffer-stock and the pay-as-you-go asset. Using a simple one-sector macroeconomic model that embeds a notional account pension system we then show how GDP-indexed government bonds, if combined with the right measure for the sustainable rate of return on contributions, could be used to generate a sustainable and secure earnings-related pension system, without becoming a fiscal burden. The proposal is particularly attractive for countries considering reforms to earnings-related systems that have accumulated a large implicit pension debt. In this case, the government bonds allow the financing of this debt in a transparent way. The proposed mechanism can also facilitate the transition to a fully funded pension system when the government bonds are allowed to be traded.
Highlights
A majority of mandatory public pension systems in the world involve an earnings-related (ER) scheme with “pay-as-you-go” financing
Even in countries that have recently adopted notional account schemes, which deal with issues related to incentives and equity, the problem of financial sustainability has not been fully resolved
In the proposed design the latter can achieve the following objectives: (i) eliminate the risk of mismanagement of the funds that inevitably accumulate during the first couple of decades, and which are necessary to finance pensions when the system matures; (ii) improve fiscal management by making the implicit liabilities of the system explicit; (iii) improve incentives for policymakers to respect rules that ensure the long-term financial sustainability of the ER system; (iv) facilitate pension reform in countries where the ER system has accumulated a large implicit pension debt; and (v) facilitate the transition to a funded scheme if the government bonds, at some point in time, are allowed to be traded
Summary
A majority of mandatory public pension systems in the world involve an earnings-related (ER) scheme with “pay-as-you-go” financing. In the proposed design the latter can achieve the following objectives: (i) eliminate the risk of mismanagement of the funds that inevitably accumulate during the first couple of decades, and which are necessary to finance pensions when the system matures; (ii) improve fiscal management by making the implicit liabilities of the system explicit; (iii) improve incentives for policymakers to respect rules that ensure the long-term financial sustainability of the ER system; (iv) facilitate pension reform in countries where the ER system has accumulated a large implicit pension debt; and (v) facilitate the transition to a funded scheme if the government bonds, at some point in time, are allowed to be traded. A formal description of the macroeconomic model and derivations of various mathematical results are presented in the Appendices
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