Download Retirement Issues

Debt and Deficits
in the face of
Baby Boom Retirement
Winter 2006
Economics 102
Core issues
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Current large fiscal deficits
Modest national debt levels
Large demographic changes
How do they add up?
deficits
Intl debt-to-GDP
Debt to GDP
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
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?]
aging
Share of 65+ in population
Old-age dependency
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
US Social Security Costs
Spending projections
The big issue is health care
reform
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
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?
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
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?
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
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
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!