Arnold Kling  

The Three Percent Solution

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The Washington Post had a story about a new paper by Robert Shiller, which can be found here. He says that the recommended "life cycle account," which mixes stocks and bonds in proportions that change as one gets closer to retirement, is unlikely to yield a return in excess of 3 percent. Since the proposals for personal accounts use the 3 percent rate to reduce Social Security benefits, that means that many people would lose under personal accounts.

As I pointed out here, the problem can be traced to the Social Security actuaries, who use the 3 percent figure to "score" reform plans.

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CATEGORIES: Social Security

COMMENTS (3 to date)
Edge writes:

The basic problem is that you can't set this rate ahead of time, just like we can't set the inflation rate, the unemployment rate, or the rate of growth of the economy by legislative fiat.

The rate charged really should reflect the cost of the money, as set by the market. But that would create even more risk than picking a fixed rate, because the market might set a rate even higher than 3%, at least on occaision (such as over the past 20 years, when real treasury bond yields have exceeded 3%).

The problem goes away for solutions that don't rely on a leveraged gamble to try to get something for nothing.

spencer writes:

For once we agree.

Boonton writes:

I read thru the Post article as well as Arnold's. Basically here is what I take to be a summary of his position:

Assuming a 3% real rate of 'risk free' return is problematic because:

1. 2% returns are more probable.
2. A 3% return is deceptive because it makes Social Securities deficits look smaller in terms of present value
3. A 3% return, when 2% is a better figure, gives 'private accounts' a higher bar to beat than is necessary to honestly be a better deal.

My thoughts:

1. If the true risk-free rate of return is 1% less than what is being predicted, then why wouldn't the 'average' return on stocks and bonds also be less?

2. Has Bush specified if the 'clawback' works off actual rates or a pre-set rate of 3%? If it is pre-set at 3% then private accounts are indeed a worse deal.

3. Aren't we just rehashing the old Equity Premium argument all over again? For retirees to 'get a better deal' the Equity Premium has to remain in force even though there's no viable economic theory to support it and it goes against theory that says markets are efficient.

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