Inter- and Intra-generational Consequences of Pension Buffer Policy under Demographic, Financial and Economic Shocks

We study the inter- and intra-generational welfare consequences of alternative pension fund policies in response to unexpected demographic, financial and macro-economic shocks. Our analysis is based on an applied OLG model of a small open economy with heterogeneous agents featuring a two-pillar pension system modelled after that in the Netherlands (with PAYG and funded tiers). We explore two policies to avoid underfunding of the pension funds. One emphasises increases in the contribution rate, while the other emphasises the reduction of indexation of pensions to price infl ation and productivity growth. Our stochastic simulations show that the welfare di¤erences between the two types of policy are generally small. They also show that the pension bu¤ers are highly volatile when the shocks are drawn from realistically modelled multivariate shock processes. Underfunding occurs relatively frequently and in any case substantially more than anticipated by the Dutch supervisor.