Sunday, September 23, 2012

Pension crisis looms despite cuts

The Wall Street Journal carried an interesting article on one aspect of the Pension Fund Death Spiral.  The article focused on how employees would rather lower their current consumption for the promise, but not the guarantee, of a payout in retirement.

Regular readers know that the Pension Fund Death Spiral is triggered by the inability of the pension funds to generate the expected earnings from their assets.  Someone has to make up this earnings shortfall.

In the case of company pension funds, the earnings shortfall is covered by the company transferring capital that could be used for reinvestment in or growth of the business.  This lowers both investment and demand in the real economy.

In the case of public pension funds, the earnings shortfall is covered by a combination of government and employee.  Employees help to cover the earnings shortfall by a) paying more into the pension fund and b) agreeing to take less out in retirement.

When employees cover the earnings shortfall, demand in the economy is permanently lowered.  It is lowered while the employee is working because a higher percentage of their salary goes to the pension fund.  It is lowered in retirement as they receive less in benefits.

There is a negative feed back loop between the decline in demand and the pension fund earnings shortfall.  As demand drops, so too does the return on the pension plans assets.  This creates the need for the earnings shortfall to be made up and making up the earnings shortfall further reduces demand.

1 comment:

Anonymous said...

Your Pension Death Spiral posts are brilliant and original.