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

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Presentation on theme: "Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-1 Figure 12-1 Two Alternative Paths of Consumption per Person."— Presentation transcript:

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

2 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-2 Table 12-1 Comparison of Consequences of IBM Debt with Those of Public Debt

3 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-3 International Perspective The Debt-GDP Ratio: How Does the United States Compare?

4 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-4 Figure 12-2 The Ratio of U.S. Government Debt to GDP, 1790–2005

5 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-5 Figure 12-3 Federal Government Revenues and Expenditures as a Percent of Natural GDP, 1960–2005

6 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-6 Figure 12-4 Components of Federal Government Expenditures as a Percent of Natural GDP, 1960–2004

7 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-7 Figure 12-5 The Laffer Curve

8 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-8 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?

9 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-9 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

10 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-10 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

11 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-11 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)

12 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-12 Figure 12-6 Social Security Outlays, Revenues, and the Trust Fund, 1985–2080

13 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-13 With Optimistic Assumptions there is no Exhaustion Date

14 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-14 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

15 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-15 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??

16 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-16 Immigration as Percent of U. S. Population, 1900-2002

17 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-17 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%

18 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-18 Population Growth per annum, 2000- 2004

19 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-19 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

20 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-20 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

21 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-21 Figure 14-1 A Flowchart Showing the Relationship Between Policy Instruments, Policy Targets, and Economic Welfare

22 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-22 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 23 Reduced Volatility (4-qtr Δ Real GDP)

24 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-24 Rolling 20-quarter Standard Deviation of 4-qtr Δs in Real GDP, 2.8 vs. 1.3 pre/post 1988:Q1

25 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-25 Figure 14-3 The Log Output Ratio and the Moving Average of its Absolute Value, 1960–2004

26 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-26 Inflation vs. Output Volatility: Sometimes the Same, but Other Times Different

27 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-27 Figure 14-4 The Federal Funds Interest Rate and the Log Output Ratio, 1980–2005

28 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-28 Figure 14-5 The Actual Federal Funds Rate and Interest Rates Calculated by Two Versions of the Taylor Rule, 1980–2004

29 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-29 Start Sims in 1979, Output Gap

30 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 12-30 Start Sims in 1979: Inflation

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