Government funds and demographic transition – alleviating ageing costs in a small open economy

Discussion Papers
Government funds and demographic transition – alleviating ageing costs in a small open economy

21/2008
Author(s):
Helvi Kinnunen
2008. 39 pages.
Publisher:
Bank of Finland
ISBN:
978-952-462-458-9
(Printed publication)
ISBN:
978-952-462-459-6
(Web publication)
ISSN:
0785-3572
(Printed publication)
ISSN:
1456-6184
(Web publication)
This paper investigates public pension funding using a dynamic general equilibrium macroeconomic model (DSGE) that facilitates investigation of distortionary effects of fiscal and pension policy responses to ageing. The model is calibrated to the Finnish economy, which will encounter substantial ageing pressures in the near future. During the transition to an older population structure ageing costs can be substantially lowered by allowing public funds to smooth out the tax responses. Cutting down on pension prefunding at a time when the pace of ageing is at its peak reduces the necessary tax hikes and stimulates labour supply growth at the moment when the labour market is tightest. With smaller funding needs, ageing leads to a slower growth in labour costs, a better employment conditions and faster production growth.