accumulation is crowded out by debt issuance that reduces the capital-labor ratio to a major extent. In fact, the real interest rate will not change at all in an open economy setting so the debt/GDP ratio will not be further inflated by higher interest rates on debt service — as it will in a closed economy where the capital labor ratio reacts endogenously — with full pass-through to the interest rate. The “true” response of, especially, the debt/GDP ratio should be found in a hybrid of the closed and open economy versions of the model, and will therefore lie between a 51 and 99 percentage point increase in the debt/GDP ratio by 2050.

**Table 4. Simulated Change in Policy-Variables by 2050 (Percentage Points 2010-Value)**

|_- in order tofinance the aging inducedfiscal costs,_|Closed Economy<br>_(percentage points)_|Open Economy<br>_(percentage points)_|
|---|---|---|
|taxes would need to increase by:|9|8|
|or,pension benefits would need to be reduced by:|11|9|
|or, debt would need to increase by:|99|51|

Source: Author’s simulations.

The general equilibrium model is structured such that retirees do not save, while retirees in Brazil, in fact, save a lot out of their aggregate income — which includes pension transfers. They do not save out of their labor income, however, thus confirming the life-cycle hypothesis. Bequests and reverse intra-household transfers from retirees to their working aged children — with whom retirees in Brazil often cohabit — should therefore also be incorporated into future research on this topic (Weil, 1997).<sup>14</sup> The large difference in saving patterns across income groups is neither taken into account. Thus, the changes in saving behavior should be adjusted downwards to some extent when considering the negative saving patterns by the share of the population in Brazil living below the poverty line.

In terms of endogenous labor supply, leisure is often considered a consumption-equivalent (normal) good, so labor supply may fall in line with economic growth. This will exacerbate the negative impact on expected labor supply following the decline in fertility but these dynamics are not taken into account (Jorgensen and Jensen, 2008b, 2010). A higher preference for leisure in utility will put upward pressure on savings, the real interest rate, and retirement consumption, as well as downward pressure on working-period consumption and leisure. In fact, Kotlikoff et al. (2001), Welch (1979) and Murphy and Welch (1992) find evidence to support that demographic change affects factor prices, which emphasizes the importance of a general equilibrium model with endogenous real interest rates and wages.

# **_Heterogeneity in Economic Behavior_**

The high income inequality in Brazil is likely to have important consequences for the possibilities and incentives for saving and investment — as the poorest income groups face somewhat different economic circumstances and incentives that non-poor income groups. This section will analyze the implications of such heterogeneity for economic behavior, capital accumulation, and the second demographic dividend.

> 14 There is a growing tendency for elderly people to live along in Brazil, which might lead to a reduced prevalence of the bequest motive. This issue should be taken into consideration in future research on this topic>

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