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Political Intergenerational Risk Sharing

Marcello D'Amato () and Vincenzo Galasso ()

No 6972, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 (search for similar items in EconPapers)
JEL-codes: D72 H55 (search for similar items in EconPapers)
Date: 2008-09
New Economics Papers: this item is included in nep-cdm, nep-dge and nep-pol
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Journal Article: Political intergenerational risk sharing (2010) Downloads
Working Paper: Political Intergenerational Risk Sharing (2009) Downloads
Working Paper: Political Intergenerational Risk Sharing (2008) Downloads
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