Monday, November 15, 2004

Debt swap?

Lots of smart people like Arnold Kling have been pointing out that the transition costs of moving social security to private accounts are an illusion. We can finance the transition by issuing bonds, and in exchange we don't have to pay out as many social security benefits. So it's just a debt swap...we exchange our implicit obligation to pay retirees with an explicit obligation to pay bond holders.

It's a good point, but I don't think it's quite right. Here's a thought experiment: suppose that tomorrow congress votes to either (A) phase in a higher social security retirement age, or (B) default on a portion of the debt, only paying (say) .98 on the dollar on the face value of all existing government bonds. How will the financial markets react to each of these announcements? (Hint: quite differently.)

Implicit debt is different than explicit debt, because it's implicit. That means we can alter the social security obligations, effectively "defaulting" on part of this implicit "debt," without destroying the economy. Andrew Samwick seems to agree with my point when he writes:

None of us are sure what would happen to interest rates if an implicit debt (unfunded obligations of an entitlement program) of $10.4 trillion were eliminated but explicit debt (Treasury bonds held by the public) were increased by a few trillion before being repaid.
To me the most sensible take on the topic is coming from the reliable Tyler Cowen.

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