Final Report Summary - DEISIP (DESIGN AND EVALUATION OF INNOVATIVE SOCIAL INSURANCE POLICIES)
This project is titled “Design and Evaluation of Innovative Social Insurance Policies” (DEISIP). The research agenda for this project is to study alternatives to current policies applied by governments in industrialized countries. The study of Social Insurance (SI) policies is motivated by the high and rapidly increasing total expenditure on SI policies in OECD countries. These expenditures have increased on average across OECD countries from 16% of GDP in 1980 to 21% in 2003 (OECD, 2007). Given these statistics, governments throughout the world are keen on either finding alternative policies to the existing ones or increasing the efficiency of current policies.
The project includes several sub-projects:
1. The design of mandatory retirement savings. In the last few decades the industrialized world has witnessed substantial demographic changes that have significant effects on retirement savings and consumption. Most importantly the increase in life-expectancy and the decline in fertility means that the dependency ratio – the number of people out of the labor force relative to those in the labor force – has increases substantially. This has immense implications for the pay-as-you-go pension systems that exist in most countries today - that use the revenue from the young to finance the expenditures of the old - in threatening the solvency of those systems as the funds collected decrease due to a decrease in fertility at the same time as the expenditure increase due to the increase in life expectancy. In such an environment it is of great importance to understand how an alternative retirement fund should be designed. A fully-funded system – where each worker has her own private account - is such an alternative. Although this has been known for quite a while only few countries have made the transition into such a system. Sweden, making a partial transition in 2000 is a rare example that is seen as a role model for the rest of the world.
I have paired with two scientists from Sweden, Roine Vestman from Stockholm University and Magnus Dahlquist from the Stockholm School of Economics in order to study the design of such a fully funded system. Using extensive data on Swedish households we are able to inquire into the financial and labor market decisions of households in order to study to what extent the financial decisions of those investors were catered for by the retirement fund policy. Our focus is the role of heterogeneity in age and other characteristics such as wealth and income for differences in financial decisions of households. We find that there are large differences in what different investors would like to do with their savings and that the government’s one-size-fits-all policy may sometimes be quite different from what is optimal for investors.
2. Following the Great Recession, there has been renewed interest in how and to what extent financial conditions affect unemployment. The correlation between the interest rate, spread, and unemployment captures this notion in a concise manner. We offer two contributions based on this observation. First, we present mechanisms by which financial conditions can affect unemployment in a search and matching model. Second, we offer a methodology for quantifying these channels. Our results suggest that financial conditions are indeed important to consider when studying unemployment dynamics. By doing this, we are introducing a new set of shocks related to financial conditions and quantifying their associated economic channels.
To this end, we follow the search and matching literature in disciplining our model and evaluating quantitative importance. Our findings suggest that the direct impact of default, owners losing their claims to profits and possible layoffs, have a small impact on unemployment volatility. However, the indirect effects of default, and other financial shocks, on interest rates have a large impact on firms, and thus on unemployment volatility. We discipline our model with US data without targeting business cycle statistics. The model is robustly able to explain about 80% of the volatility of unemployment, vacancies, and market tightness. Additionally, the simulations show that financial shocks can account for about half of the rise of unemployment during the Great Recession, and that Federal Reserve policies prevented unemployment from rising an additional 6%.
The project includes several sub-projects:
1. The design of mandatory retirement savings. In the last few decades the industrialized world has witnessed substantial demographic changes that have significant effects on retirement savings and consumption. Most importantly the increase in life-expectancy and the decline in fertility means that the dependency ratio – the number of people out of the labor force relative to those in the labor force – has increases substantially. This has immense implications for the pay-as-you-go pension systems that exist in most countries today - that use the revenue from the young to finance the expenditures of the old - in threatening the solvency of those systems as the funds collected decrease due to a decrease in fertility at the same time as the expenditure increase due to the increase in life expectancy. In such an environment it is of great importance to understand how an alternative retirement fund should be designed. A fully-funded system – where each worker has her own private account - is such an alternative. Although this has been known for quite a while only few countries have made the transition into such a system. Sweden, making a partial transition in 2000 is a rare example that is seen as a role model for the rest of the world.
I have paired with two scientists from Sweden, Roine Vestman from Stockholm University and Magnus Dahlquist from the Stockholm School of Economics in order to study the design of such a fully funded system. Using extensive data on Swedish households we are able to inquire into the financial and labor market decisions of households in order to study to what extent the financial decisions of those investors were catered for by the retirement fund policy. Our focus is the role of heterogeneity in age and other characteristics such as wealth and income for differences in financial decisions of households. We find that there are large differences in what different investors would like to do with their savings and that the government’s one-size-fits-all policy may sometimes be quite different from what is optimal for investors.
2. Following the Great Recession, there has been renewed interest in how and to what extent financial conditions affect unemployment. The correlation between the interest rate, spread, and unemployment captures this notion in a concise manner. We offer two contributions based on this observation. First, we present mechanisms by which financial conditions can affect unemployment in a search and matching model. Second, we offer a methodology for quantifying these channels. Our results suggest that financial conditions are indeed important to consider when studying unemployment dynamics. By doing this, we are introducing a new set of shocks related to financial conditions and quantifying their associated economic channels.
To this end, we follow the search and matching literature in disciplining our model and evaluating quantitative importance. Our findings suggest that the direct impact of default, owners losing their claims to profits and possible layoffs, have a small impact on unemployment volatility. However, the indirect effects of default, and other financial shocks, on interest rates have a large impact on firms, and thus on unemployment volatility. We discipline our model with US data without targeting business cycle statistics. The model is robustly able to explain about 80% of the volatility of unemployment, vacancies, and market tightness. Additionally, the simulations show that financial shocks can account for about half of the rise of unemployment during the Great Recession, and that Federal Reserve policies prevented unemployment from rising an additional 6%.