Archive for April 2nd, 2020

How costly are pension reform reversals?

April 2, 2020

Daniel Baksa, Zsuzsa Munkacsi and Carolin Nerlich in this research:

Europe’s population is ageing, and this trend is expected to continue over the coming decades. The demographic changes are captured by the change in the old-age dependency ratio, which measures the size of the elderly population – defined as people aged 65 years and older – in relation to the working-age population – aged 15-64. According to Eurostat, between now and 2070 the ratio for the euro area will rise strongly from 30% to 52%, with considerable differences across countries. Two-thirds of this increase will be concentrated in the next decade and a half, as the large “baby boom” generation born 1955-70 will be over 65, while life expectancy will keep rising and the fertility rate will remain low or fall even further.

Ageing societies are facing major macroeconomic challenges. Labour forces are shrinking and precautionary savings are likely increasing, while rising pension expenditures can pose a risk to the sustainability of pay-as-you-go pension schemes. To relieve the burden on public finances, most euro area countries have adopted sizeable pension reforms since the early 2000s. Among the most effective reforms are those that lift the retirement age, in particular if it is adjusted automatically to changes in life expectancy (Carone et al., 2016). More recently, however, a number of governments have been facing strong political pressure to undo past reforms. How costly are reversals of pension reforms for the economy and public finances? How do they affect intergenerational burden sharing? What measures are needed to compensate if public debt levels are rising due to reversals?

In a forthcoming ECB working paper (Baksa, Munkacsi and Nerlich, 2020), we explore these questions. To do so, we apply a new approach that allows us to quantify not only the macroeconomic and fiscal impact of population ageing and pension reforms, but also that of reform reversals. We show that in the long run reversing pension reforms can be very costly. This would not only result in higher pension expenditure and public debt, but could also worsen the adverse macroeconomic impact of ageing and make the public pension system more intergenerationally unfair.

Europe is in such a bad shape..

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