Sunday, September 19, 2010

A lens into macro policy: Pension problems

     News outlets have recently been discussing underfunded pension funds. This discussion has been well timed given a recent concern of mine regarding macroeconomic policies. I have been questioning why it is that deflation and slow or no growth economic periods are so harmful to our economy, but more so why must macroeconomic policy always be pushed as expansionary? I don't understand why we must push for greater and greater growth than can be achieved without government intervention. The way I see it, expansionary policies are a form of economic leverage. For example, as opposed to having economic growth of 1%, expansionary policies leverage this growth to 3.5%. Why must a nation constantly force greater growth, as opposed to allowing organic expansion?

     I cannot see how any form of "macro-management" can go on forever, there must be a point at which economic policies cannot continue to support unsustainable growth rates. The US may be good modern example of when expansion works for a time, but will eventually be unsustainable. One would be hard pressed to find someone who believes that the US can continue to borrow to finance its economic expansion, as that is what all the borrowing is for. Yes, the US borrowed to stabilize its economy, but nonetheless this was to prevent economic contraction, but why not allow things to run a more natural course. Although I am a firm believer that the economy needed to be buoyed during this crisis, I do not see sustainability in constant expansionary policies.
     This brings me to pension funds. The Economist does a good job of explaining the risk of economic contraction for pensions: "deflation is a hidden risk for pension schemes. If it occurs, it will cut the nominal incomes of those (companies, public-sector bodies) that have to fund future pensions, creating another potential gap between assets and liabilities." To prevent such gaps expansionary policy must be maintained. It is simple, as long as long as the economy expands pension contributors should be able to fund their pensions due to rise in incomes from inflation and economic expansion. But as I have said, this is an unsustainable model; it is quite possible that the current model for pension funds is also unsustainable. It is most certainly unsustainable when near 8% annual returns are required for funds to meet payment needs. 
      Given such a deficit in pension assets, the Economist reports, more saving will be needed to shore up the funds. This will come from a paradigm shift of "borrow now, pay later" to "save now, rather than starve later." In other words, investors will begin to save more, as the fear a prolonged low interest rate environment and retirement uncertainty. 
    Whatever the reasons for consistent expansionary policy, it should be not be taken so lightly. An unsustainable model will fail at some point and the pension fund capital issue is an example of how this may be occurring today. 

Sept. 20, 2010 --- Related Article

`Death Spiral' Besets State Pensions as Benefits Grow
http://www.bloomberg.com/news/2010-09-15/-death-spiral-awaits-state-worker-pensions-as-illinois-leads-underfunding.html


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The Economist article quoted is Buttonwood | Another paradox of thrift; Sept. 18, 2010
The pension returns is from the Economist article Finance after the crisis: CalPERS Sept. 18, 2010

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