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A life cycle analysis of social security

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We develop an applied general equilibrium model to examine the optimal social security replacement rate and the welfare benefits associated with it. Our setup consists of overlapping generations of 65-period lived individuals facing mortality risk and individual income risk. Private credit markets, including markets for private annuities, are closed by assumption. Unlike previous analyses, we find that an unfunded social security system may well enhance economic welfare. In our benchmark economy, the optimal social security replacement rate is 30%, and an empirically more plausible replacement rate of 60% raises welfare compared with an economy with no social security system.

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We would like to thank Andy Atkeson, V. V. Chari, Steve Davis, Paul Evans, Lars Hansen, Tim Kehoe, Nobu Kiyotaki, Ed Prescott, José-Victor Ríos-Rull, Richard Rogerson, Tom Sargent, Nancy Stokey, Dick Sweeney, Robert Townsend, and the participants of the NBER Economic Fluctuations Small Group Workshop on Micro and Macro Perspectives on the Aggregate Labor Market in Palo Alto, the NBER General Equilibrium Theory Conference in Minneapolis, the Money and Banking Workshop at the University of Chicago, and the NBER Summer Institute. An earlier version of this paper was titled “A Dynamic Stochastic General Equilibrium Analysis of Social Security.” This material is based upon work supported by the National Science Foundation under Grant No. SES-9210291. We also thank the Minnesota and San Diego Supercomputer Centers for their support.

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İmrohoroglu, A., İmrohoroglu, S. & Joines, D.H. A life cycle analysis of social security. Econ Theory 6, 83–114 (1995). https://doi.org/10.1007/BF01213942

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