Dynamic Efficiency and Pareto Optimality in a Stochastic OLG Model with Production and Social Security

We analyze the interaction between risk sharing and capital accumulation in a stochastic OLG model with production. We give a complete characterization of interim Pareto optimality. Our characterization also subsumes equilibria with a PAYG social security system. In a competitive equilibrium interim Pareto optimality is equivalent to intergenerational exchange e¢ciency, which in turn implies dynamic e¢ciency. Furthermore, dynamic e¢ciency does not rule out a Pareto-improving role for a social security system. Social security can provide insurance against macroeconomic risk, namely aggregate productivity risk in the second period of life (old age) through dynamic risk sharing. We brie‡y relate our results to models without uncertainty where the notions of exchange e¢ciency, dynamic e¢ciency and interim Pareto optimality are all equivalent in a competitive equilibrium. JEL classi...cation: D61, H55