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Debt and Deficits in the face of Baby Boom Retirement Winter 2006 Economics 102.

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Presentation on theme: "Debt and Deficits in the face of Baby Boom Retirement Winter 2006 Economics 102."— Presentation transcript:

1 Debt and Deficits in the face of Baby Boom Retirement Winter 2006 Economics 102

2 Core issues Current large fiscal deficits Modest national debt levels Large demographic changes How do they add up?

3 deficits

4 Intl debt-to-GDP

5 Debt to GDP

6 Sustainable? Yes, if debt/GDP doesn’t rise much If GDP increases at (1+g) then debt needs to increase by less –Deficit including interest must be less than g or about 4% [2% real plus 2% inflation] –With debt of 80% of GDP and 5% interest that component is 4% of GDP Thus on average need balanced budget –Note that this includes social security

7 First glance US doesn’t look so bad Need to close 4% of GDP gap –Some small portion cyclical, 0.5% of GDP? Hence reduce expenditures –Not much “fluff” outside of defense –If can cut defense by 1% of GDP… Else must raise taxes –Must undue much of Bush tax cuts –Net around 1.5%, assuming we end the “war on terror” [that is, creating more terrorists?]

8 aging

9 Share of 65+ in population

10 Old-age dependency

11 Baby boomers Retirees per worker shifting Since pensions are pay-go, either taxes or savings must rise –Given the past 2 decades in the US, we shouldn’t be optimistic about the latter –Hence “saving” social security is critical Pension related numbers are not huge Health care costs are


13 US Social Security Costs

14 Spending projections

15 The big issue is health care reform

16 Future shifts Social security perhaps +2% of GDP –Combination of modest cuts to benefits Modest increases in taxes Gradual boost in retirement age Health care –+4% of GDP in optimistic case Present value is 5x social security

17 So how add up? Current structure is large international imbalances Result of low domestic savings and high government dissavings (S-I) + (T-G) = (X-M) 0/- - --in magnitude So what changes with retirement?

18 need +2.5% of GDP to correct deficits +2.0% of GDP to fund pensions +5.0% of GDP to cover health care +10% of GDP as order of magnitude –Absent effective health care reform


20 Back to S-I savings invesment balance (S-I) + (T-G) = (X-M) Need boost T gradually –Not a crisis, multiplier impact if do too quickly Flash point: crowding out –Can we run larger trade deficits Permitting more workers to shift to health care –Will we squeeze investment? Ditto, but resulting in lower long-term growth?

21 What happens if we annoy OPEC? Money fungible: global savings flows matter, not whether Dubai buys US bonds –Could have significant short-term impact Slow rise in interest rates –Accompanied by depreciation of dollar My prediction: pain both at home and internationally –High interest rates squeeze growth –High prices (weak dollar) squeezes consumption

22 Politics Open questions: not my specialty –Econ majors required to take politics! Little sense that proactive policy likely Bankruptcies due to “legacy” costs –Force more onto Federal budget and force reform? Health care crisis –Force interventions to keep hospitals open and doctors in practices? Interest rate erosion –Market forces will keep gradual but stimulate politics? High debt to GDP will potentially make it hit deficits in short run

23 The good side US productivity growth robust –But need to improve education! US demographics strong –Especially if we don’t clamp off immigration Our debt all in dollars –Foreign exchange crisis impossible –So can inflate away what you owe to the rest of the world But not on Bernanke’s watch!

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