EUROPE - European Union countries with capital-funded pensions systems will be negatively affected in the long-term if countries with a pay-as-you-go (PAYG) system finance their increased pension obligations through debt, according to research conducted at Tilburg University.

Yvonne Adema, economist producing a dissertation at Tilburg University, has argued pension reforms therefore need joint decision-making at EU level, as her investigation found inflationary pressures on that debt eventually reduce the value of funded schemes.

Adema's research has focused on how countries with different pension systems - and different saving behaviour as a consequence - affect each other through capital markets.

According to the economist, rising debt - created through increasing PAYG costs generated by ageing populations - is an incentive for lobbying the European Central Bank (ECB) for surprise inflation.

Unexpected inflation damages pensions funding for countries with a capital-funded system, especially where they have invested in government bonds of PAYG countries, Adema pointed out.

"Indebted PAYG countries, in particular, would benefit from inflation because this decreases their financial burden. Conflicting national interests, in combination with insufficient transparent decision-making at the ECB, could trigger a market response to inflation risk," Adema argued.

According to Adema, higher inflation risk makes government bonds less attractive and requires a higher risk premium. This will increase the debt tax and lower savings and capital-labour ratio in all - but mainly PAYG - countries, she explained.

In the economist's opinion, it is important to countries of the Economic and Monetary Union (EMU) with a funded system that debt levels of PAYG countries stay within the parameters of the Stability and Growth Pact.

"Moreover, an independent, credible and transparent ECB, with a clear monetary policy strategy, is important to all EU countries," Adema stressed.

A sudden transformation of PAYG into a funded system will initially have a negative impact on the older generations in ‘funded countries', as increased savings will drive interest rates down, Adema suggested.

Yvonne Adema is a researcher at Tilburg University and Netspar, the network for studies on pensions, ageing and retirement. She is also affiliated with the Netherlands' Bureau for Economic Policy Analysis (CPB).

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