How Do Pensions Affect Household Wealth Accumulation?

Empirical analysis of the effects of pensions on saving behavior is usually based on a highly stylized version of the life cycle model, with a fixed retirement age, a perfect capital market, no uncertainty, and no institutional constraints on pensions. The model predicts one-for-one crowd out of household wealth by pension wealth over the life cycle. Empirical estimates of crowd out are usually much closer to zero, and it is not well understood whether such estimates are accurate indications of the true magnitude of crowd out or whether the strong assumptions imposed in the analysis result in severe misspecification. In this paper, I specify a richer life cycle model in which several of the key restrictions of the simple model are relaxed. The effects of pensions on household wealth are analyzed by solving and simulating the model. The compensating variation associated with pensions is treated as a measure of crowd out. The simulated data are then used to estimate regressions like those typically found in the literature. Preliminary results indicate that regression estimates of the effects of pensions on wealth accumulation estimated under the assumptions of the typical stylized life cycle model are quite misleading when those assumptions do not hold. Specifically, the extent of crowd out is substantially underestimated in the regression approach. This finding may help explain the common although not universal empirical finding of small crowd out.

saving behavior/saving/pensions/Methodology/Crowding out

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