Aging US Baby Boomers To Have Major Economic Effect – Fed Paper

WASHINGTON (Dow Jones)–The retirement of U.S. baby boomers will lead to a steep decline in U.S. consumption unless measures are taken quickly to smooth the adjustment and boost labor force participation such as increasing the retirement age, according to a paper released Tuesday by the Federal Reserve.

The timing of the paper’s public release is notable as it comes just two days ahead of Fed Chairman Ben Bernanke’s scheduled testimony before a Senate committee on the nation’s long-term fiscal outlook.

The paper’s conclusions suggest lawmakers and Fed officials have a shared interest in entitlement reform.

“Barring a significant increase in labor force participation, population aging will lead to a reduction in per capita consumption relative to a baseline in which the demographic composition of the population does not change,” Fed economists Louise Sheiner, Daniel Sichel and Lawrence Slifman wrote.

That suggests a major impact on the overall U.S. economy, since consumption accounts for roughly two-thirds of gross domestic product.

The Fed paper, dated September, was posted on the Fed’s Web site Tuesday.

Economists have long fretted about the impact entitlement programs such as Social Security and Medicare will have on federal spending once the nearly 80 million baby boomers – those born between 1946 and 1964 – start retiring. The oldest baby boomers can begin drawing Social Security benefits as early as 2008.

Unless changes are made to Social Security and Medicare, economists warn that the programs will consume an ever-larger share of government revenue and lead to either massive spending cuts or tax hikes.

Bernanke, in an October 2006 speech, observed that population aging affects the economy as well, noting that the reductions in output and consumption “represent an economic burden created by the demographic transition.”

With the share of the working population likely to be on the decline, each worker’s output will have to be shared by more people, meaning less consumption, Bernanke explained.

The Fed paper, meanwhile, suggests the economic and fiscal policy links are interconnected. “The question of how to deal with the problem of achieving financial balance in entitlement programs for the elderly cannot be divorced from the basic question of how society responds to population aging,” the Fed economists said.

The Fed paper also puts some numbers to the economic effects and highlights the consequences of inaction, while offering a roadmap on how to evaluate any reform proposals.

According to the Fed economists, assuming no increase in labor force participation, consumption would need to decline by 4.4% starting now in order to adjust for the retirement of baby boomers. If the consumption adjustment – through policies such as reduced entitlement benefits and higher taxes – were to be put off until 2025, then spending would need to fall by 13.7% compared with what it would otherwise be.

“As these results indicate, the size of any consumption reduction depends critically on whether the adjustment happens sooner or later and on whether the labor force participation of the elderly changes,” the authors concluded.

“Reform plans intended to achieve solvency should be evaluated in terms of whose consumption path is lowered and when and by how much it is cut,” they added.

The Fed economists also said that a higher retirement age could significantly limit the hit to the economy.

If the retirement age were immediately boosted by two years, to 67, then consumption would only need to fall by 0.7% as a result of baby boomer retirement, they estimated.

An immediate increase to 70, meanwhile, “would be more than enough to offset the effects of aging and would allow consumption to increase considerably,” the Fed economists wrote.

One wild card, the economists said, is the rate of U.S. productivity growth. If productivity grows more than the authors assume, then the consumption adjustment would be lower.

If it slows, however, then consumption would need to fall even more, the authors said.

By Brian Blackstone; Dow Jones Newswires