Trade-Off Effect of Pay-As-You-Go Public Pension on Economic and Welfare Volatility

Using an overlapping-generations model where heterogeneous individuals choose their own consumption and labor supply for responding to total factor productivity shocks, this paper finds a trade-off effect of pay-as-you-go public pension on macroeconomic stability and welfare volatility. This paper theoretically proves that pay-as-you-go public pension can reduce volatilities of total consumption and social welfare at the cost of increasing volatilities of aggregate output, labor supply, and investment. By reducing the exposure of retirement wealth to aggregate shocks, pay-as-you-go public pension can make individuals work and save less in recessions and more in booms.