Computable Stochastic Equilibrium Models and Their Use in Pension- and Ageing Research

This paper surveys recent advances in the field of computable general and partial equilibrium models dealing with pension issues that take into account various aspects of uncertainty. Whereas previous quantitative research with deterministic models solely focussed on efficiency losses due to labor market distortions from pay-as-you-go (paygo) financing, stochastic simulation models highlight the insurance effects of social security systems and allow to quantify the welfare consequences from myopic behavior. The results from these studies challenge the common wisdom about the cost and benefits of social security. While previous studies typically either recommended a move towards a more funded system or proposed a tight tax-benefit linkage, recent results from stochastic models indicate that welfare losses due to reduced insurance coverage compensate the gains due to improved labor market incentives. Consequently, paygo financing and progressive benefit formulas should not be eliminated on pure efficiency grounds. Current research tries to qualify whether this conclusion is robust in models with private insurance institutions and/or macroeconomic risks.