The effects of financing rules in pay-as-you-go pension systems on the life and the business cycle

Abstract Empirically, revenues of public pension systems are more volatile than expenditures. Therefore, the question arises how the social security authority should buffer its revenues and adjust its contributions over the business cycle. This paper studies the corresponding effects on the life cycle of households and the business cycle in a large-scale overlapping generations model. In particular, the labor supply is endogenous and takes the intertemporal links between contributions and pension benefits into account. Sluggish adjustments of contribution rates that are implemented by adjusting a financial buffer stock both stabilize an economy and decrease the volatility of lifetime utilities of most workers and retirees, in contrast to sole adjustments of contribution rates. However, changes of consumption, capital income, or lump sum taxes, which aim to balance public pension budgets, improve the allocation of aggregate risk across cohorts for people up to an age of at least 71 years.