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The US Social Security program was created in part as an explicit response to the Great Depression. We evaluate the performance of Social Security as a protective safety net against a rare episode of sudden and significant loss of private wealth such as the Great Depression. We construct a model in which a rare event causes a shock to wealth at an unknown time. How well does Social Security function as a safety net against such risk? The answer depends critically on whether households optimize in the face of this risk. If the household has full information on the distribution of rare event risk and solves a dynamic stochastic problem to hedge this risk, then Social Security is unnecessary along this dimension. Alternatively, if the household does not account for rare event risk in its financial planning, then Social Security can provide very large welfare gains as a safety net. [ABSTRACT FROM AUTHOR]

This paper quantifies the welfare gains from Social Security when individuals face uninsurable longevity risk. While past researchers have studied this basic question, we do so from a unique perspective. In contrast to traditional macroeconomic models that abstract from specific linkages between parents and children, in our model, children are born to specific parents whose longevity is uncertain. And because parental asset holdings evolve over the life of the parent, children face uninsurable bequest income risk in addition to their own longevity risk. We find that Social Security improves ex ante expected utility by 3.4% of lifetime consumption (for the second generation). Because our baseline analysis assumes full information and optimal hedging of longevity risk, we treat these welfare gains as a conservative estimate, and we show that the gains are significantly larger when individuals fail to hedge their longevity risk. [ABSTRACT FROM AUTHOR]

Edward C. Prescott has argued that mandatory saving is socially desirable because it solves the problem of people intentionally free riding and becoming a welfare burden. Inspired by Prescott's argument, we develop a model in which rational individuals choose between saving and free riding. We find that free riding is a robust outcome for a significant share of the population and that everyone, including the free riders, benefits from the elimination of free riding through mandatory saving. Our results strengthen Prescott's position that free riding is a serious problem and that mandatory saving is socially desirable. [ABSTRACT FROM AUTHOR]

The Save More Tomorrow™ (or SMarT) plan has proven effective in raising employee saving rates and appears to be popular among participants and the media. An important question has remained on the minds of economists despite this success: just how close does the prescriptive SMarT plan come to approximating the normative life-cycle/permanent-income consumption rule? That is, does it pay (in a lifetime utility sense) to participate in a SMarT plan? We attempt to provide some rigorous answers to this question by employing a quantitative- theoretic model to perform dynamic welfare analysis, and our results tend to support the SMarT plan as a decent first approximation to the life-cycle/permanent-income rule. We also consider the problem of an altruistic employer seeking to maximize the lifetime utility of employees by appropriately choosing the default SMarT parameters in the face of employee heterogeneity in saving rates and uncertainty about whether they will actually stick with the plan. The employer's problem is augmented to include employee heterogeneity concerning risk taking, and we also consider the possibility that SMarT saving may be met with increased borrowing. [ABSTRACT FROM AUTHOR]