The cost of uncertainty about the timing of Social Security reform

Abstract

We develop a model to study optimal decision making in the face of uncertainty about the timing and structure of a future event. The model is used to study optimal decision making and welfare when individuals face uncertainty about when and how Social Security will be reformed. For young individuals with many years to optimally hedge the risks that they face, the welfare cost of uncertainty about the timing and structure of reform is just a few basis points of total lifetime consumption. In contrast, the cost of reform uncertainty can be greater than 1% of total lifetime consumption for individuals close to retirement, even if they have saved optimally up to that point. Finally, the cost is significantly higher still for those who do not save optimally to hedge these risks.