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Throughout the world, people contribute to and benefit from social security programs like that in the United States. Yet, owing to demographic changes and other factors, the US Social Security system as we currently know it is unlikely to survive. The challenges faced by the United States are present in many other countries with similar demographics. In much of the developed world, the ratio of workers to retirees will decrease over the next decades. Armed with the tools of this chapter, you are now equipped to understand the implications of proposed changes to Social Security programs, both in the United States and the rest of the world.
Our analysis of Social Security combines two tools often used in macroeconomics. The first is the life-cycle model of consumption/saving, which provides insights into how individuals and households make consumption and saving decisions over long time horizons. We saw that people do not have to match their consumption to their spending each year; instead they can save or borrow to keep their consumption relatively smooth over their lifetimes. However, they must still satisfy a budget constraint over their entire lifetime.
The second is the government budget constraint. We first examined the case where the government kept the Social Security system in balance. In this case, revenues and payments were equal each year. Then we examined the case where the government did not necessarily match revenues and spending. In this case, there is still an accounting of government flows that links surpluses and deficits today with future obligations.
Our discussion illustrates a very important fact about how the economy works: household behavior typically responds to government policy. In the case of Social Security, we saw that households reduce their saving when the government saves on their behalf.
Social Security Administration
Using the life-cycle model, how would the level of consumption respond to an increase in