Friday, October 06, 2006

Will We Treat Future Generations Fairly?

That's the subtitle of Fed Chairman Ben Bernanke's speech at the Washington Economic Club on Wednesday this week. In it he discusses the implications of the aging of the baby boomers and the ongoing increases in life expectancy. Economically, it's not a pretty picture, but it'll only get worse if we keep putting off doing anything about it.

...the broader perspective shows clearly that adequate preparation for the coming demographic transition may well involve significant adjustments in our patterns of consumption, work effort, and saving. Ultimately, the extent of these adjustments depends on how we choose--either explicitly or implicitly--to distribute the economic burdens of the aging of our population across generations. Inherent in that choice are questions of intergenerational equity and economic efficiency, questions that are difficult to answer definitively but are nevertheless among the most critical that we face as a nation...the fiscal consequences of these trends are large and unavoidable. As the population ages, the nation will have to choose among higher taxes, less non-entitlement spending, a reduction in outlays for entitlement programs, a sharply higher budget deficit, or some combination thereof.

He points out that if we tried to finance projected entitlement spending (Social Security and Medicare) entirely by revenue increases, our tax burden would have to go up by one-third over the next 25 years. If we tried to address it by cutting non-entitlement spending, we would have to cut the federal budget by $700 billion in today's terms. If we increase the federal budget deficit to pay for it, we shift the burden of paying for government spending to future generations.

In addition, Bernanke points out that the aging of the population is likely to lead to lower average living standards, all other things being equal. As the population ages, the share of working age (and employed) population decreases. Basically, this implies that the level of output per person must be lower since each worker's output will have to be shared among more people.

Bernanke argues that one way to mitigate these affects would be to increase our national savings rate, which could be used to increase our nation's capital stock which would make future workers more productive. The problem is that saving more now means that we need to consume less or work more. The tradeoff: "We can mitigate the adverse effect of the aging population on future generations but only by foregoing consumption or leisure today."

Citing a stylized model (i.e. a model that's not realistic, but illustrates the implications of changing saving and consumption now versus later) that the Fed has created (see the speech itself for more details), he points out

...the decisions that we make over the next few decades will matter greatly for the living standards of our children and grandchildren. If we don’t begin soon to provide for the coming demographic transition, the relative burden on future generations may be significantly greater than it otherwise could have been. At the heart of the choices our elected representatives will have to make regarding the distribution of these costs across generations will be an issue of fairness: What responsibility do we, who are alive today, have to future generations? What will constitute ethical and fair treatment of those generations, who are not present today to speak for themselves?

I think Bernanke brings up some important points. By not doing anything to address these issues now, we're really putting the issue on future generations by default. As the father of three young children, that would be like me saying I'm going to keep spending and not worry about the bill because I'll make them pay for it when they grow up. We really owe it to our children to educate ourselves about the hard choices that we'll collectively have to make and to push our elected officials to look beyond their next election. Since our children (or our future children) don't have any voice, we'll have to speak for them.

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