The commitment value of funding pensions

Abstract

This paper studies how funding public pensions can improve policy outcomes when short-sighted governments cannot commit. We focus on sustainable plans, where optimal nonlinear pensions are not reneged on by sequential governments. Funding pensions is a commitment mechanism. It implies lower contributions than does the second best policy, which reduces temptation to over-redistribute later and to misuse revealed private information. Funding may be preferable even if the population growth rate is higher than the rate of return on assets. Second best optimal policies are also more likely to be renegotiation proof under fully funded pensions.