The Impact of Public Pension Deficits on Households' Investment and Economic Activity

US public state pension deficits are very large, accounting for 18.5% of an average state's GDP and up to 50% in Illinois. In principle, households should respond to this heavy future burden by increasing current savings, particularly in safe assets, since pension deficits are countercyclical. Comparing households residing on opposing sides of states' borders, I document that households in larger-deficit states save more, investing more in safe bank deposits and less in risky stocks. Specifically, households hold 0.70 dollars more in deposits and 0.35 dollars less in stocks for each additional dollar of pension deficit. This effect strengthened further following the implementation of new accounting standards in 2015 that made deficits more salient by requiring states to publicly disclose them. Exploiting staggered state pension reforms, I also find that households respond consistently when states reduce pension deficits; they shift savings from deposits to stocks. These reallocations spill over onto local economic activity: as households withdraw deposits following a pension reform, exposed local banks cut lending to local businesses, lowering employment and wages, especially in the non-tradable sector.