Working Papers

Abstract: Pay-as-you-go (PAYG) pension schemes are heavily affected by demographic risks. To mitigate the financial burden, mixed pension schemes that combine elements of funding and PAYG have been proposed. In this paper, we introduce a mixed scheme framework designed for a shrinking working-age population given a specific level of pension expenditure. We evaluate its performance using both the one-year ruin probability and the Value at Risk of the accumulated deficits over time. We also examine the implications of guaranteeing a return of zero on the investments within the funding scheme. Furthermore, we explore the creation of a buffer fund that invests part of the capital in the financial markets, thereby alleviating the financial pressures of the PAYG part. Our findings indicate that, although the proposed mixed framework does not hedge against demographic risk, it enhances the financial health of the system, delaying the need for pension reforms as a result.

Keywords: public pensions, demographic risks, investment, sustainability, ruin probability, value-at-risk, investment

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2024Jun

Understanding Australian Migration 2024

Peter McDonald

Introduction: The sudden rise of net overseas migration in Australia to over half a million in 2022-23 has given rise to a much broader debate on the benefits of immigration and to the likelihood that immigration will be an issue in the next Federal election. It is timely therefore to review how the massive increase in net overseas migration occurred and what is its likely future pathway. Both major political parties and electors consider that net migration should not continue at this very high level and both parties have plans to bring the level down rapidly. This paper aims to provide an understanding of how the rise in net migration occurred and, hence, how net migration can be brought down to an acceptable level most effectively.

The paper provides a discussion of the rationales of the Australian migration program and stresses the importance of drawing a distinction between temporary and permanent migration. This distinction and its implications would be much clearer if the Australian Bureau of Statistics divided the Estimated Resident Population into the permanent population (Australian citizens and permanent residents and New Zealand citizens) and the temporary population.

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2024Jun

Home Equity Release in Retirement: The Role of Behavioural Factors, Aged Care and Bequests

Katja Hanewald and Hazel Bateman

Introduction: In Australia, as in many countries, housing wealth is a key component of retiree household savings. This was underscored by the 2020 Retirement Income Review (Australian Treasury, 2020), which reported that for most households aged 65 and over, the family home is their largest asset. The review found that using superannuation assets more efficiently and accessing equity in the home can significantly boost retirement incomes without the need for additional superannuation contributions. Based on modelling and projections, the review concluded that using relatively small portions of home equity can substantially improve retirement incomes and that releasing home equity can boost retirement incomes with a modest impact on debt.

Australian retirees have several equity release options to access the wealth tied up in their homes without having to sell the property. The government’s Home Equity Access Scheme (formerly Pension Loans Scheme) allows older Australians to supplement retirement income by accessing home equity, with repayment deferred until the home is sold. Similarly, reverse mortgages offered by different providers allow homeowners to borrow against their home equity, with the loan repaid upon selling the property, relocating, or at the borrower’s death. Other options include home reversion schemes, where a portion of the home’s equity is sold for either a lump sum or regular payments, and shared appreciation agreements, which provide payments in exchange for a share in the property’s future sale value. While these options are increasingly recognised for their potential to improve financial flexibility in retirement, their overall uptake remains modest, suggesting a need for greater public awareness and understanding.

This paper aims to provide background information, summarise recent research in this area and identify policy suggestions.

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2024Jun

Global Economic Impacts of Physical Climate Risks on Agriculture and Energy

Roshen Fernando

Abstract: Climate change continues to be an existential threat to humanity. With intrinsic linkages to the natural environment, food and energy supply chains are two fundamental channels via which climate risks could spill over into the economy. This paper explores the global economic consequences of the physical climate impacts on agriculture and energy. Firstly, we construct a range of chronic and extreme climate risk indicators. Secondly, we incorporate those climate risk indicators, alongside the historical data on global agriculture and energy, in machine learning algorithms to estimate the historical responsiveness of agriculture and energy to climate risks. Thirdly, we project agriculture and energy production changes under three Shared Socioeconomic Pathways (SSPs). Finally, the derived shocks are introduced as economic shocks to the G-Cubed model, which is a global multisectoral intertemporal general equilibrium model. We evaluate the G-Cubed model simulation results for various economic variables, including real GDP, consumption, investment, exports and imports, real interest rates, and sectoral production. We observe substantial losses to all economies and adjustments to consumption and investment under the SSPs. The losses worsen with warming. Developing countries are disproportionately affected. However, we observe the potential for double dividends from transitioning to sustainable livestock production and renewable energy sources, preventing further warming and physical damages, and enhancing the resilience of food and energy supply chains to climate risks.

Keywords: Climate Change, Extreme Events, Physical Climate Risks, Macroeconomics, CGE, DSGE, Machine Learning

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2024Jun

Impact of Physical Climate Risks on Financial Assets

Roshen Fernando

Abstract: Climate change poses substantial risks to global socioeconomic stability. The financial sector of the economy could be affected by climate risks both independent of the real sector and due to the linkages with the real sector. Understanding these linkages is crucial not only to prevent the vulnerability of the financial sector to climate risks but also to effectively utilize the financial markets to raise finance for mitigation and adaptation efforts. This paper explores the impacts of physical climate risks on the risk premia of financial assets. We employ a range of climate indicators representative of chronic and extreme climate risks and a mix of panel regressions, machine learning, and local projections to examine the contemporaneous and persistent effects of physical climate risks on financial assets. We also investigate the exposure of different economic subsectors and assets to physical climate risks. We observe that employing a suite of climate indicators enriches the understanding of the impacts of physical climate risks on financial assets. Most of these pathways align with the impacts on the real sector of the economy via sectoral productivity. The physical climate risks could have persistent effects for several years, both at the aggregate and sectoral levels. Different assets could experience similar effects, although safer assets could reduce the exposure of asset portfolios to climate risks.

Keywords: Climate Change, Financial Markets, Econometrics, Machine Learning, Local Projections

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2024Jun

Global Economic Impacts of Antimicrobial Resistance

Roshen Fernando and Warwick McKibbin

Abstract: Antimicrobial resistance (AMR) is a growing global health threat that led to 1.27 million deaths in 2019. Given the widespread use of antimicrobials in healthcare, agriculture, and industrial applications and a range of factors affecting AMR, including demographic trends and physical climate risks, an economy-wide approach is essential to understand and assess the economic consequences of AMR. We model the global economic impacts of AMR under six alternative scenarios. These scenarios are designed to incorporate assumptions about changes in AMR-related disease incidence, the impact of a central scenario about future demographic change on AMR over time, and explore the sensitivity of assumptions about the effects of AMR on agriculture productivity. We also examine the additional impacts of changing climate risks on the evolution of AMR (focusing on one climate scenario), the consequences of changes in country risk premia due to the differential impacts of the evolution of AMR on countries, and the global economic impacts of changes in government expenditure in response to AMR. Our results find a significant global economic burden of worsening AMR due to demographic change and climate change risks, as well as significant economic benefits of taking action to address AMR. We emphasize that a “one-health” approach to managing AMR will have substantial economic benefits over the coming decades.

Keywords: Antimicrobial Resistance, Antibiotic Resistance, Infectious Diseases, Economic Modelling

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2024May

Sectoral Choices and Household Welfare in Emerging Economies: Evidence from Vietnam

Huyen Hoang and George Kudrna

Abstract: This study examines the effects of sectoral choices between formal and informal labour on household consumption and welfare in emerging economies. Analysing data from the Vietnam Household Living Standards Survey (2014-2018), we investigate two main questions: (1) What factors influence sectoral labour choices? and (2) How do these choices impact household consumption and welfare? We use a multinomial logit model to show that sectoral choices are primarily influenced by education level, gender, and marital status. The analysis extends to propensity score matching, supplemented by instrumental variable and multinomial endogenous switching regression models. Our results indicate that entering informal employment, particularly by low-skill workers, significantly reduces spending on food, while high-skill employment induces higher consumption of non-durable goods. Interestingly, informal employment increases housing wealth compared to low-skill formal employment, suggesting that informal workers invest in safe assets to mitigate high employment risks, while formal workers diversify their assets portfolio. The findings highlight the need for improved professional training and social security measures to facilitate transitions from informal to formal employment, enhancing household welfare.

Keywords: Informality, Sectoral choice, Structural change, Welfare, Propensity score matching, Multinomial endogenous switching regression

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2024Mar

Progressive Income-Contingent Student Loans

Yue Hua and George Kudrna

Abstract: Progressive income contingent loans (ICLs) for college students, where repayment rates increase with income, may provide additional insurance against income risks after graduation. We study how the progressiveness of ICLs affects life-cycle behaviors and welfare. We document stylized facts on education in Australia, where recent reforms made ICLs more progressive. We found correlations between reforms and enrolment rates. We estimate income dynamics and found that progressive ICLs provide more insurance in the first repaying years. Lastly, we build a heterogenous-agent life-cycle model and find that progressive ICLs induce higher education attainment and welfare than non-contingent loans or linear ICLs.

Keywords: Student loans, income-contingent repayment, income dynamics, heterogeneous-agent life-cycle model

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2024Mar

Intergenerational Risk Sharing in Pay-As-You-Go Pension Schemes

Hélène Morsomme, Jennifer Alonso-García and Pierre Devolder

Abstract: Population ageing undermines traditional social security pension systems that combine pay-as-you-go (PAYG) and defined benefits (DB). Indeed, demographic risk, if guaranteed benefits remain unaltered, will be borne entirely by workers through increases in the contribution rate. To avoid a substantial increase of the contributions and in order to maintain simultaneously the financial sustainability and the social adequacy of the public pension system, risk sharing and automatic balancing mechanisms need to be put in place. We present a two-step convex family of risk-sharing mechanisms. The first shares the risk between contributors and retirees through adjustments in the contribution rate, used to calculate the global covered wage bill, and the benefit ratio that represents the relationship between average pensions and wages. The second step studies how the retirees’ risk should be shared between the different retirees’ generations through adjustments in the replacement rate and a sustainability factor that affects pension indexation during retirement. We perform a detailed study of the effect of social planner’s targets and solidarity weight between various generations in a deterministic and stochastic environment.

Keywords: risk-sharing, automatic balancing mechanisms, pension design, ageing

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