A Dynamic Inconsistency Problem in PAYG: A Solution to the Turkish Puzzle

Because of the dynamic inconsistency problem in optimal policies of pay-as-you-go (PAYG) systems, parametric reforms tend to be unfair in terms of generational justice and could be inefficient in terms of optimal level of consumption. As long as there are adverse shocks, the planner has to decide on generational distribution of the financial burden in PAYG systems. In this paper we show that if intergenerational transfers are needed to keep the system in balance, any discretionary policy that allocates these transfers between the elderly and the young becomes dynamically inconsistent and the system moves toward being a Ponzi scheme. This may be part of the reason why the government has not been able to resist abusing the system by increasing its generosity for the elderly while expectations on social security wealth for new members have been declining for the last 40 years in Turkey.