Friday, November 12, 2004

Prescott disappoints

Ed Prescott is a very smart economist who deserved his recent Nobel prize, but he doesn't seem so smart in today's WSJ:
Some politicians have vilified the idea of giving investment freedom to citizens, arguing that those citizens will be exposed to risks inherent in the market. But this is political scaremongering. U.S. citizens already utilize IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank you....Consumers already know how to invest their money -- why does the government feel the need to patronize them when it comes to Social Security?

So just because consumers are now exposed to some risk it makes sense to expose them to more risk.

It would be one thing if the government's Social Security system paid a decent return, but as the President's Commission reported, for a single male worker born in 2000 with average earnings, the real annual return on his currently-scheduled contributions to Social Security will be just 0.86%. ... A bank would have to offer a pretty fancy toaster to get depositors at those rates of return.
You'd think Prescott would know what he's talking about, since he co-authored, with Rajnish Mehra, the a paper on the equity premium puzzle that is one of the most famous papers in economics. But according to a recent paper by Mehra on the topic, the mean real return from 1947-2000 on a "relatively riskless security" was 0.6%. And this is for T-bills and the like, your average bank will do even worse. Prescott seems to be trying to win his point with naive readers by ignoring the distinction between real and nominal interest rates.

There may be some good arguments for adding private accounts to social security, but these aren't them. (via Alex Tabarrok, who liked the piece a lot more than I did.)

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