Aging and Pensions in General Equilibrium: Labour Market Imperfections Matter

We re-examine the effects of population aging and pension reforms in an OLG model
with labor market frictions. The most important feature brought about by labor market
frictions is the connection between the interest rate and the unemployment rate. Exogenous
shocks (such as aging) leading to lower interest rates also imply lower equilibrium
unemployment rates, because lower capital costs stimulate labor demand and induce firms
to advertise more vacancies. These effects may be reinforced by increases in the participation
rate of older workers, induced by the higher wage rates and the larger probability of
finding a job. These results imply that neglecting labor market frictions and employment
rate dynamics may seriously bias the evaluation of pension reforms when they have an
impact on the equilibrium interest rate.