Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-1 Figure 12-1 Two Alternative Paths of Consumption per Person

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-1

Figure 12-1 Two Alternative Paths of Consumption per Person


Table 12-1 Comparison of Consequences of IBM Debt with Those of Public Debt


International Perspective The Debt-GDP Ratio: How Does the United States Compare?


Figure 12-2 The Ratio of U.S. Government Debt to GDP, 1790–2005


Figure 12-3 Federal Government Revenues and Expenditures as a Percent of Natural GDP, 1960–2005


Figure 12-4 Components of Federal Government Expenditures as a Percent of Natural GDP, 1960–2004


Figure 12-5 The Laffer Curve


Social Security: Is there a Crisis? Is the Solution Difficult?

• Social Security is Simple in the U. S.– Other Nations should envy our population

growth

– Our official projections are incredibly pessimistic

– The required “fixes” are very minor

– The political battle: are personal accounts worth the transition cost?


Essentials of Current System

• Basic contrast between “defined contribution” and “pay as you go”

• Tax rates are changed rarely, so surplus or deficit depends on expenditures relative to revenues

• “Dependency Ratio”, ratio of beneficiaries to workers

• Depends on population growth and structure


Chronology of the Baby Boom

• High birth rate 1947-64

• They become age 65 2012-2029

• After 2012 there is a steady increase in the dependence ratio

• Steady increase in benefits, smaller population of workers


Why Should the U. S. Have a Problem?

• Not quite “pay as you go”• 1983 Reforms built up quite a head start on

the baby boom problem– 1983 reforms together with Reagan and Bush tax

cuts => subtle exercise in class warfare

• Will peak in 2012-15, then decline until zero in ~2045– The “exhaustion date” depends on assumptions,

particularly– Productivity growth– Population growth (fertility, mortality, immigration)


Figure 12-6 Social Security Outlays, Revenues, and the Trust Fund, 1985–2080


With Optimistic Assumptions there is no Exhaustion Date


Caution on what “Exhaustion” Means

• After the trust fund is gone, revenues will still cover 81% of benefits

• Increase in tax rate from 12 to 15 or 16 percent will keep system solvent forever

• But with more optimistic assumptions, no need for future tax increases


How the Assumptions Matter

• Productivity:– Current system raises benefits by real

wage through retirement, then only inflation

• Population growth– Fertility = 2.0 (compare to Europe!)

– Mortality ignores medicare effect (explain)

– Immigration!• Will the population in 2080 be 415m or 600m??


Immigration as Percentof U. S. Population, 1900-2002

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1900 1920 1940 1960 1980 2000

Legal immigration

Legal plus illegal immigrationa

Percent


Immigration: the Shining Light

• Immigration / Population ratio grew at 3.5 percent per year 1970-2002

• Ratio currently at 1.4/300 = 0.46%• Official projections based on constant 1.2

million forever, so ratio declines to 0.29% by 2080

• Allowing ratio to taper off to a constant 0.5% implies 2080 population of 600 million, not 415

• Implies permanent population growth of 1.0%, not 0.2%


Population Growth per annum, 2000-2004

Population Growth

0

0.2

0.4

0.6

0.8

1

1.2

1

Pe

rce

nt

Un

ited

Sta

tes

Ca

na

da

Fra

nce

UK Japan Italy

Germany


Solutions are Easy

• Faster Productivity Growth puts off crisis

• Faster population growth puts off crisis

• How to solve crisis, whenever it comes– Index retirement age to life expectancy

– Raise ceiling on taxable income (currently $90K)

• Unnecessary to cut benefits or raise tax rates– Raising retirement age is an implicit cut in total

benefits but not in benefits paid out per year

– Raising ceiling makes financing system less regressive


Bush Proposal: Personal Accounts

• Divert 2% into personal accounts from existing tax of 12%

• This robs the system of 1/6 of its revenue

• Creates a multi-trillion $ financing hole

• The assumption of a continuing equity premium ignores history– Greater macroeconomic stability implies less risk

– Remaining equity premium, if any, is a reward for risk

• Can allow SS Trust Fund to invest in stocks


Figure 14-1 A Flowchart Showing the Relationship Between Policy Instruments, Policy Targets, and Economic Welfare


Figure 14-2 The Percent Change in Real GDP Following a 1 Percentage Point Change in the Treasury Bill Rate, Three Intervals, 1961–2004

23

-4

-2

0

2

4

6

8

10

12

14

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Perc

en

t p

er

year

Actual Real GDP Growth

Average Real GDP Growth

Reduced Volatility Reduced Volatility (4-qtr (4-qtr ΔΔ Real GDP) Real GDP)


Rolling 20-quarter Standard Deviation of 4-qtr Δs in Real GDP, 2.8 vs. 1.3 pre/post 1988:Q1

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Perc

en

t


Figure 14-3 The Log Output Ratio and the Moving Average of its Absolute Value, 1960–2004


Inflation vs. Output Volatility:Sometimes the Same, butOther Times Different

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Real GDP Growth Volatility

Inflation Volatility


Figure 14-4 The Federal Funds Interest Rate and the Log Output Ratio, 1980–2005


Figure 14-5 The Actual Federal Funds Rate and Interest Rates Calculated by Two Versions of the Taylor Rule, 1980–2004


Start Sims in 1979, Output Gap

-8

-6

-4

-2

0

2

4

6

1965:01 1970:01 1975:01 1980:01 1985:01 1990:01 1995:01 2000:01

Volcker

Greenspan

Burns


Start Sims in 1979: Inflation

0

2

4

6

8

10

12

1965:01 1970:01 1975:01 1980:01 1985:01 1990:01 1995:01 2000:01

Greenspan

Volcker

Burns

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Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-1 Figure 12-1 Two Alternative Paths of Consumption per Person