Demographic Change and the Rate of Return in PAYG Pension Systems

The currently observed demographic change consists of two independent developments that differ in structure and persistence: (1) A slow, monotonic and (presumably) permanent ageing effect caused by an increasing life expectancy; (2) a more rapidly changing, non-monotonic and less permanent cohort effect caused by fluctuations in the size of cohorts. This paper shows the ageing effect has a positive impact on the rates of return households generate within pay-as-you-go (PAYG) pension system. The cohort effect, by contrast, results in winners and losers in PAYG systems. Taking Germany as an example and using a quantitative OLG model the paper shows that the two effects cause rate of return differentials within the pension system of almost 1.3 percentage points between generations.