Abstract
We employ a two-country overlapping-generations model to explore the international dimension of household portfolio choices induced by the asymmetric provision of government-run pensions. We study the resulting patterns of risk-sharing and the corresponding welfare effects on both home and foreign agents. Introducing the defined benefits pay-as-you-go system at home increases the welfare of all other agents at the expense of the home workers and improves the degree of intergenerational risk sharing abroad. Conversely, a defined contributions system leads to welfare losses of both home cohorts accompanied by gains abroad, but does increase the extent of intergenerational risk sharing at home.
Acknowledgments
We would like to thank conference participants at the 2018 Infiniti Conference on International Finance, Southern Economic Association 2018 Annual Meeting, and the 14th Annual Conference of Macroeconomists from Liberal Arts Colleges for valuable comments and suggestions. All remaining mistakes are our own.
The Social Planner’s Problem
The social planner maximizes the Lagrangian (21) by choosing the optimal home and foreign consumption levels of each cohort, where (5) and (6) can be monotonically transformed by
into
and consumption baskets are defined in (1).
This optimization gives the following first order conditions:
Note that the equations for the young and old cohorts are the same for each country, which implies that
Plug the optimal consumption ratios (26) into the definitions of the consumption baskets (1) to get optimal bundles in terms of only home or foreign consumption:
Recombine the Euler equations (25) with optimal ratios (26) to solve for consumption of home goods by the young home cohort and consumption of foreign goods by the young foreign cohort:
Solve for the optimal consumption bundles in terms of the Lagrangian multipliers using (27) and (28):
Equation (29) imply the following:
Observe that
represents the CPIs of the home and foreign consumption baskets, respectively. Recall the definition the RER as
Then equation (30) implies that
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