Working Paper: NBER ID: w7103
Authors: Peter Diamond; John Geanakoplos
Abstract: Social Security trust fund portfolio diversification to include some equities reduces the equity premium by raising the safe real interest rate. This requires changes in taxes. Under the hypothesis of constant marginal returns to risky investments, trust fund diversification lowers the price of land, increases aggregate investment, and raises the sum of household utilities, suitably weighted. It makes workers who do not own equities on their own better off, though it may hurt some others since changed taxes and asset values redistribute wealth across contemporaneous households and across generations. In our companion paper we reconsider the effects of diversification when there are decreasing marginal returns to safe and risky investment. Our analysis uses a two-period overlapping generations general equilibrium model with two types of agents, savers and workers who do not save. The latter represent approximately half of all workers who hold no equities whatsoever.
Keywords: Social Security; Investment; Equities; Welfare; Overlapping Generations Model
JEL Codes: H55; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trust fund portfolio diversification into equities (G11) | welfare improvements (I38) |
| Trust fund portfolio diversification into equities (G11) | sum total of utility in the economy (D11) |
| Trust fund portfolio diversification into equities (G11) | benefits for workers (J32) |
| Trust fund portfolio diversification into equities (G11) | weak Pareto gain (D61) |
| Trust fund portfolio diversification into equities (G11) | expected output increases (E23) |
| Diversification (G11) | increases the safe rate of interest (E43) |
| Diversification (G11) | reduces the equity premium (G12) |
| Increase in bond rate of return (E43) | improves returns for bonds (G12) |
| Increase in bond rate of return (E43) | higher government interest payments (H63) |
| Higher government interest payments (H63) | change in taxes (H29) |
| Change in taxes (H29) | could hurt savers (D14) |
| Diversification (G11) | ambiguous welfare effect on young savers (D14) |
| Increase in income taxes from government debt burdens (H69) | ambiguous welfare effect on young savers (D14) |
| Gains from falling land prices (R31) | ambiguous welfare effect on young savers (D14) |
| Trust fund diversification (G23) | raises the welfare of workers (J89) |