Abstract:
This paper studies the dynamic and steady state properties of optimal intergenerational insurance when enforcement is limited in a pure exchange and stochastic overlapping generation economy. The optimal allocation is chosen by a benevolent government whose welfare function values the initial old and places a positive but vanishing weight on the welfare of future generations. The optimal allocation is constrained to be self-enforceable. Therefore, generations must have no incentive to default in consumption allocation at any point in time and any contingency. We show that the optimal intergenerational insurance when enforcement is limited takes the form of a history-dependent pension plan payable by the young to the old generation. The distribution of consumption implied by the optimal intergenerational insurance converges along a saddle path to a stationary distribution. We find that the model is consistent with empirical observations of intergenerational consumption correlations. Finally, our analysis provides novel implications about the design of optimal institutions for intergenerational risk-sharing.
Photo: Vegard Wiborg