Pension and Labor Market Reforms, Behavioral Adaptions and Macroeconomic Implications

The pressing demographic transition and the negative effects of early retirement urged countries to take reforms that could no longer wait to be implemented, given the risk of unsustainability and the financial crisis that undermined the budgets of countries in the last decade. Facing this challenge, numerous reforms have been put forward by policy makers to promote more active aging and a longer working life. We build a rich overlapping generations (OLG) model in order to quantify the effects of pension reforms on retirement ages and macro-economic indicators in the face of demographic change. An endogenous retirement decision is explicitly modeled within a public pension system. Heterogeneity with respect to consumption preferences, wage profiles and survival rates is embedded in the model. By combining confluent strands in literature on micro incentives for retirement, life-cycle behavior and OLG models with population aging, we examine the macro-economic impact of different reform scenarios of the pension system. Besides the expected direct effects of these reforms on the behavior of households, we observe that feedback-effects occur. Results suggest that individual retirement decisions are strongly influenced by numerous incentives produced by the pension system and macro-economic variables: the statutory eligibility age, adjustment factors, the presence of a replacement rate and interest rates influence retirement decisions made by households. Those decisions, in turn, have several impacts on the macro-economy which can create feedback cycles. Taken together, these reform scenarios have strong implications for the sustainability of pension systems. It is essential to understand reactions of households to pension reforms and the possible endogenous equilibrium effects to evaluate pension reforms. Because of the rich nature of our unified model framework, we are able to rank the reform proposals according to several measures and draw policy recommendations. This project will result in a MEA Discussion Paper and is currently being circulated among researchers working on this topic.