Papers to shock the unwary

by on September 10, 2006 at 4:46 am in Economics | Permalink

The lead article in the August 2006 Journal of Political Economy offers the following abstract:

We solve each household’s optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earning and medical expenses, progressive taxation, government transfers, and pension and social security benefits.  With optimal decision rules, we compare, household by household, wealth predictions from the life cycle model using a nationally representative sample.  We find, making use of household-specific earnings histories, that the model accounts for more than 80 percent of the 1992 cross-sectional variation in wealth.  Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are undersaving is generally small.

In other words, most Americans are saving enough for their retirements.  The authors (John Karl Scholz, Ananth Seshardi, and Surachai Khiatrakun) stress that their data cover only the early 90s, although if anything they believe this biases their estimates downwards by missing out on later capital gains.  Here is the paper.

Notes: This result does not deny that America may face coming demographic problems for funding social programs, most of all Medicare.  But next time you read that "the U.S. savings rate is zero," think back on this blog post and on that paper.

1 Richard September 10, 2006 at 8:42 am

On quick read, the paper uses a 2.2% real discount rate to compute the present value of retirment needs and a 4% real rate of return on investments. This can cause them to understate the net worth needed to generate adequate income.

2 Lee A. Arnold September 10, 2006 at 10:25 pm

Yes — although if you actually go out and talk to moderately wealthy retirees, you will learn that some of them took a bath in the last stock market crash, and are depending upon Social Security much more than they thought they would. Every retiree I have spoken with, from richest to poorest, says Leave Social Security alone!

3 Keith September 11, 2006 at 12:26 am

“Every retiree I have spoken with, from richest to poorest, says Leave Social Security alone!”

Given that their return on Social Security at the margin is now infinite, I’d say that’s not a surprising response.

4 DK September 11, 2006 at 8:57 am

Lee Arnold wrote: “Although if you actually go out and talk to moderately wealthy retirees, you will learn that some of them took a bath in the last stock market crash, and are depending upon Social Security much more than they thought they would.”

This sounds like moral hazard to me. It’s a lot easier to put your life savings into internet stocks when you know Social Security will bail you out.

5 spencer September 11, 2006 at 10:39 am

The savings rate is income less spending and the spending
includes that financed by borrowing. Simple.
So saving includes the initial contribution to IRAs,401’s,
etc., but does not include the capital gains in such
accounts.

It is negative because we spend more then we earn — simple.

Here we are only talking about what individuals do.

If you want to look at total national savings add this to business and govt savings — a big negative — and you get a savings -investment gap that is equal to what we borrow from foreigners to consume more then we produce.

I’m not sure this is the paper I remember and I have not read it but isn’t the biggest factor in the good position in consumer savings the value of defined benefit retirement programs that have massively declined since the early 1990s . If this is what I think it is — without reading it- because of how it treats defined benefit pensions it is way, way, way too optimistic about current conditions.

6 Murphy September 12, 2006 at 11:38 am

I live in a relatively rich area (Fairfax County VA). Bssed on anecdotal statements from many of my friends, who are high earners by they way, people are not saving enough for retirement. I see so many people borrowing on their houses for current consumption. So many people obviously living beyond their current and reasonably anticipated future income. And we are not even talking about people in the less fortunate areas of the US. How does anyone earning at the median income or less save anything?

I recognize that this is anecdotal and not strictly evidenced based. But I see it over and over.

7 Foobarista December 12, 2006 at 2:47 am

Actually, personal savings rates do NOT include 401K contributions or traditional IRA contributions (although Roth IRAs do count) because it’s computed on disposable income, which is computed on taxable income. 401Ks and traditional IRAs are not part of taxable income. Also, the employer match on 401K is not counted as personal savings, although most people would think of it that way. And as mentioned, investment growth doesn’t count either, but passive income that’s saved does count…

I realized that my wife and I had a negative savings rate by the national calculations last year because we had maximally funded our 401Ks and paid cash for a car. But if 401K contributions were counted, we saved 20% of our gross, even if the car is counted as pure consumption (which we do…)

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