The endogenous determination of retirement age and Social Security benefits

Abstract

An ageing population in modern societies has put stress on public pension systems. To prevent Social Security deficits from increasing to unbounded stocks of public debt we focus on two policies: reducing the generosity of pension benefits, determined by the government, and post- poning the effective retirement age, chosen by employees. An atomistic employee would disregard the effect of his retirement decision on the public debt and would retire as soon as possible. Conversely, an ideal farsighted agency considering all current and future employees would postpone re- tirement, thereby alleviating the pressure on public debt and allowing for a more generous long-run pension. The government may design a proper incentive strategy to induce myopic atomistic decision-makers, to act non-myopically. This strategy is a two-part incentive with non-linear dependence on the stock of public debt. It is credible if deceiving em- ployees slightly adjust their retirement age decisions to increments in the public debt.