Procyclicality of Pension Fund Regulation and Behaviour

Abstract

This paper studies the labour market effects of pension fund restoration plans at a business cycle frequency. During a recession, pension funds’ funding ratios typically drop significantly and regulations force funds to restore their buffers by increasing their contributions, lower future indexation or cut liabilities immediately. Using a standard search and matching model of the labour market, I find that especially raising contribution rates has significant amplification effects on the key labour market statistics. A less distorting solution is to let pension rights fluctuate with the value of the pension assets and to use pension contributions only to finance new rights. This paper shows that risk sharing via the pension system will amplify labour market fluctuations, something not taken into account by standard risk sharing recipes.