Commentary on "Discretion, Rules and Volatility

C ostas Azariadis and Vincenzo Galasso address a basic but very important question about the social security system. What are the incentives for young workers to contribute funds and thus maintain such a system? The issue is to understand the economic and political forces that combine to provide the foundations for a social security system. The starting point of the analysis is perhaps one of the most familiar propositions in macroeconomics. Consider a simple overlapping generations (OLG) model in which identical agents live and consume in each of two periods and have endowments of goods in both periods of life. Though agents are identical within a generation, the potential exists for exchange across generations. Competitive equilibria of this economy may be inefficient: Owing to the infinite horizon, it may be possible to start at autarky (a competitive equilibrium) and redistribute goods across agents of different generations. The desirability of this intergenerational redistribution comes from the pattern of endowments and the nature of intertemporal preferences as shown in Figure 1 of “Discretion, Rules and Volatility.”