Optimal policies in an ageing society

Abstract

We analyze optimal social security in an overlapping generations model with demographic change and endogenous retirement. Households choose to spend the second period of their lives in full retirement if the tax rate on labor income exceeds a threshold. This threshold is increasing in life expectancy and decreasing in the fertility rate, which implies that both types of demographic change increase the relevance of the partial retirement case: both an increase in life expectancy and a drop in fertility imply that retirement is delayed. We also show that when the government decides about retirement, the command optimum can be replicated through social security policies if the laissez-faire equilibrium features capital overaccumulation. When households decide about their retirement themselves, however, replication of the command optimum is not possible. In both cases, it is optimal to expand social security when longevity increases and to reduce it when fertility drops.