The basic economic assumptions are embodied in three alternatives that are designed to provide a reasonable range of effects on Social Security’s financial status. The intermediate assumptions reflect the Trustees’ consensus expectation of an underlying general trend toward moderate economic growth throughout the projection period and the expected levels of various economic parameters. The low-cost assumptions represent a more optimistic outlook and assume relatively strong economic growth and relatively optimistic levels for other parameters. The high-cost assumptions represent a relatively pessimistic scenario, with weak economic growth, two
recessions in the short-range period and relatively pessimistic levels for other parameters. For this report, all three sets of assumptions include an extension into the projection period of the recession that started in December 2007 with lower productivity in 2009 and unemployment peaking in 2010.
Actual economic data was available through the third quarter of 2008 at the time the assumptions for this report were set. The data indicated that economic activity peaked in December 2007
1 with the level of output (GDP) above the long-term sustainable trend level. Economic growth subsequently weakened with the level of output reaching the sustainable trend level by the middle of 2008. The actual growth rate in real GDP was slightly negative for the third quarter of 2008 and was projected to be significantly negative for the fourth quarter in all three alternatives. For the intermediate and low-cost alternatives, the current recession was projected to be followed by a recovery period with economic growth sufficient to return output to the sustainable level, but not beyond that level. For the high-cost alternative, the economy is assumed to experience a second recession before returning only to the sustainable level of output. Under all three sets of assumptions the economy is assumed to reach and maintain a sustainable, potential trend level of output by the end of the short-range period. Economic cycles are not included in the assumptions beyond the first 10 years of the projection period because complete cycles have little effect on the long-range estimates of financial status.
For this year’s intermediate projections, real GDP growth is assumed to decline through the second quarter of 2009. The recovery from the recession brings economic activity to the projected stable, sustainable path by the end of 2015. For 2017 and later, real GDP is projected to be about 1.4 percent lower than in the 2008 report, based on recent data and the effects of the recession. These revised economic assumptions account for about half of the estimated reduction in the program’s actuarial balance relative to last year’s report. The effect of the recession on the actuarial balance would be smaller than projected in this report if the recovery were such that economic output substantially overshoots the projected sustainable path, a phenomenon observed in some past business cycles.
The following sections 1 through
4 present the principal economic assumptions for the three alternatives that are summarized in table
V.B1. The subsequent sections
5 through
7 present additional economic factors, summarized in table
V.B2, that are critical to the projections of the future financial status of the combined OASI and DI Trust Funds.
Total U.S. economy productivity is defined as the ratio of real gross domestic product (GDP) to hours worked by all workers.
2 The rate of change in total- economy productivity is a major determinant in the growth of average earnings. For the 40 years from 1967 to 2007, annual increases in total productivity averaged 1.7 percent, the result of average annual increases of 2.0, 1.3, 1.3, and 2.1 percent for the 10-year periods 1967-77, 1977-87, 1987-97, and 1997‑2007, respectively. However, it should be noted that this growth rate of 1.7 percent reflects a shift of employment from low (farm) to high (nonfarm) productivity sectors that is not expected to continue in the future.
Because productivity growth can vary substantially within economic cycles, it is most useful to consider historical average growth rates for complete economic cycles. The annual increase in total productivity averaged 1.6 percent over the last five complete economic cycles (measured from peak to peak), covering the 41-year period from 1966 to 2007. The annual increase in total productivity averaged 2.2, 1.2, 1.2, 1.6, and 2.0 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, and 2000-07, respectively.
The ultimate annual increases in productivity are assumed to be 2.0, 1.7, and 1.4 percent for the low-cost, intermediate, and high-cost assumptions, respectively, and are consistent with ultimate annual increases in non-farm productivity of 2.4, 2.0, and 1.7 percent. These rates of increase are the same as those used in the 2008 report, and reflect the belief that recent strong growth in non‑farm business productivity, after the relatively poor performance from 1973 to 1995, is consistent with future long-term growth that mirrors the long-term trends of the past.
In the near term for the intermediate assumptions, the negative growth in real GDP is assumed to continue through the first half of 2009. The quarterly change in real GDP (on an annual basis) is assumed to be ‑0.5, ‑6.0, ‑4.0, and ‑1.5 percent for 2008Q3 (i.e., the third calendar quarter of 2008), 2008Q4, 2009Q1, and 2009Q2, respectively. The total decline in real GDP from 2008Q2 to 2009Q2 is assumed to be 3.0 percent, giving this recession the largest consecutive quarterly decline in real output since the 1957‑58 recession. The economy is assumed to begin recovering in 2010 and reach its full-employment or sustainable trend level of output in 2015. The annual change in real GDP is assumed to be 1.1 percent for 2008, ‑2.2 percent for 2009, 2.4 percent for 2010, and to average about 3.6 percent over the 5‑year recovery period from 2010 to 2015. Following this pattern, the annual change in total‑economy productivity is assumed to be 1.8 percent for 2008, 0.3 percent for 2009, 2.8 percent for 2010, and to average about 1.9 percent over the 5‑year recovery period from 2010 to 2015. The annual change in total‑economy productivity then falls to its assumed ultimate annual rate of 1.7 percent in 2018 and later.
For the low-cost assumptions, the economy is assumed to experience a milder recession and a faster recovery. The annual change in total‑economy productivity is assumed to be 1.8, 0.6, 2.9, 2.5, and 2.2 percent for 2008, 2009, 2010, 2011, and 2012, respectively, and to average the assumed ultimate annual rate of 2.0 percent thereafter. For the high-cost assumptions, the annual change in productivity decreases from 1.7 percent for 2008 to 0.0 percent for 2009. Thereafter, the annual change in productivity varies with economic cycles until reaching its ultimate growth rate of 1.4 percent for 2020.
Future changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI) will directly affect the OASDI program through the
automatic cost-of-living benefit increases. Future changes in the GDP price index (GDP deflator) affect the nominal levels of GDP, wages, self-employment income, average earnings, and
taxable payroll.
Historically, the CPI increased at an average annual rate of 4.6 percent for the 40 years from 1967 to 2007, the result of average annual increases of 6.1, 6.3, 3.4, and 2.6 percent for the 10-year periods 1967-77, 1977-87, 1987-97, and 1997-2007, respectively. The GDP deflator increased at an average annual rate of 4.1 percent from 1967 to 2007, the result of average annual increases of 6.0, 5.5, 2.7, and 2.3 percent for the same respective 10-year periods.
The ultimate annual increases in the CPI are assumed to be 1.8, 2.8, and 3.8 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These rates of increase are the same as those used in the 2008 report, and reflect a belief that future inflationary shocks will likely be offset by succeeding periods of relatively slow inflation due to persistent international competition, and that future monetary policy will be similar to that of the last 20 years, with its strong emphasis on holding the growth rate in prices to relatively low levels.
For each alternative in the 2008 report, the ultimate annual increase in the GDP deflator was assumed to be equal to the annual increases in the CPI minus a 0.4 percentage point price differential. The price differential is based primarily on methodological differences in the construction of the two indices. For the 2009 report, the ultimate annual increase in the GDP deflator is assumed to be equal to the annual increases in the CPI minus a 0.3, 0.4, and 0.5 percentage point price differential for the low-cost, intermediate, and high-cost alternatives, respectively. Varying the ultimate projected price differential across alternatives better recognizes the historical variation in this concept. Hence, for the 2009 report, the ultimate annual increase in the GDP deflator is assumed to be 1.5 (1.8 less 0.3), 2.4 (2.8 less 0.4), and 3.3 (3.8 less 0.5) percent for the low-cost, intermediate, and high-cost alternatives, respectively.
For the intermediate assumptions, the annual change in the CPI is assumed to decrease from 4.3 percent for 2008 to ‑1.0 and 1.7 percent for 2009 and 2010, respectively, due to the effects of the recession and a decline in the price of a barrel of oil in late 2008. The annual change in the CPI is assumed to gradually increase to 3.1 percent for 2013 as the economy recovers and the demand for oil increases. The annual change in the CPI is assumed to recede to its assumed ultimate annual increase of 2.8 percent for 2015 and later. Because the level of the CPI in 2009Q3 and 2010Q3 is not assumed to be above the level of the CPI in 2008Q3, the automatic cost‑of‑living benefit increase for 2009 and 2010 is projected to be 0.0 percent. The price differential, defined as the percent change in the CPI less the percent change in the GDP deflator, is estimated to be 2.1 percentage points for 2008 and projected to be ‑2.1 percentage points for 2009. This swing in the price differential is due to the dramatic rise of oil prices for 2008 and the subsequent fall to lower average prices for 2009. The rise and fall in oil prices affected CPI much more than the GDP deflator because oil is a much larger share of what we consume than of what we produce in the U.S. As the economy recovers, the relative price of oil rises and the price differential is assumed to average about 0.8 percentage point over the 4‑year period from 2010 to 2013. After the economy returns to full employment, the relative price of oil stabilizes and the price differential is assumed to fall to its ultimate assumed value of 0.4 percentage point for 2015 and later.
For the low-cost assumptions, the annual change in the CPI is assumed to decrease from 4.3 percent for 2008 to ‑1.2 and 1.3 percent for 2009 and 2010, respectively. Thereafter, the annual change in the CPI is assumed to gradually increase to 2.1 percent for 2013 and then decrease to its assumed ultimate annual change of 1.8 percent for 2015. For the high-cost assumptions, the annual change in the CPI is assumed to decrease from 4.3 percent for 2008 to ‑0.4 and 2.2 percent for 2009 and 2010, respectively. Thereafter, the annual change in the CPI is assumed to gradually increase to 6.0 percent for 2013 and then decrease to its assumed ultimate annual change of 3.8 percent for 2015.
The average level of nominal earnings in OASDI covered employment for each year has a direct effect on the size of the taxable payroll and on the future level of average benefits. In addition, under the automatic-adjustment provisions in the law, growth in the average wage in the U.S. economy directly affects certain parameters used in the OASDI benefit formulas and additional parameters used for the computation of the contribution and benefit base, the exempt amounts under the retirement
earnings test, the amount of earnings required for a quarter of coverage, and under certain circumstances, the automatic cost-of-living benefit increases.
Average U.S. earnings is defined as the ratio of the sum of total U.S. wage and salary disbursements and proprietor income to the sum of total U.S. military and total civilian household employment. The growth rate in average U.S. earnings for any period is equal to the combined growth rates for total U.S. economy productivity, average hours worked, the ratio of earnings to compensation (which includes fringe benefits), the ratio of compensation to GDP, and the GDP deflator. Assumed future growth rates in productivity and the GDP deflator are discussed in the previous two sections.
The average annual change in average hours worked was ‑0.2 percent over the last 40 years, and -0.7, -0.1, 0.3, and -0.4 percent for the 10-year periods 1967-77, 1977-87, 1987‑97, and 1997‑2007, respectively. The average annual change in average hours worked was -0.3 percent over the last five complete economic cycles covering the period from 1966 to 2007. The annual change in average hours worked averaged -0.7, -0.6, 0.0, 0.1, and ‑0.6 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, and 2000‑07, respectively.
For the 2009 report, the ultimate annual rates of change for average hours worked are assumed to be 0.1, 0.0, and -0.1 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These ultimate annual rates of change for average hours worked are the same as those assumed for the 2008 report.
The average annual change in the ratio of earnings to compensation was ‑0.2 percent from 1967 to 2007. For wage workers, the assumed ultimate annual rates of change in the ratio of earnings to compensation are -0.1, -0.2, and ‑0.3 percent for the low-cost, intermediate, and high-cost assumptions, respectively. Under the intermediate assumptions, the ratio of wages to employee compensation is projected to decline from 0.813 for 2008 to 0.695 for 2083. The ratio of compensation to GDP is assumed to be stable.
Thus, the ultimate projected annual growth rate in average U.S. earnings is about 3.9 percent for the intermediate assumptions. This growth rate reflects assumed ultimate annual growth rates of about 1.7, -0.2, 0.0, and 2.4 percent for productivity, the ratio of earnings to compensation, average hours worked, and the GDP deflator, respectively. Similarly, the ultimate projected annual growth rate in average nominal U.S. earnings is 3.5 percent for the low-cost assumptions and 4.3 percent for the high-cost assumptions.
Over long periods of time the average annual growth rates in average U.S. earnings and average earnings in OASDI covered employment are expected to be very close to the average annual growth rates in the average wage in OASDI covered employment (henceforth the “average covered wage”). Thus, the assumed ultimate annual growth rates in the average covered wage are 3.5, 3.9, and 4.3 percent for the low-cost, intermediate, and high-cost assumptions, respectively. For the intermediate assumptions, the annual rate of change in the average covered wage is assumed to decrease from 3.3 percent for 2008 to 0.7 percent for 2009, following the recession to its low point. As the economy recovers, the annual rate of change in the average covered wage is assumed to increase to 3.4 percent in 2010 and to average about 4.1 percent over the 5‑year period from 2011 to 2015. Thereafter, the annual rate of change in the average covered wage decreases and reaches its assumed ultimate rate of change of 3.9 percent for 2018.
For simplicity, real increases in the average OASDI covered wage have traditionally been expressed in the form of real-wage differentials—i.e., the percentage change in the average covered wage minus the percentage change in the CPI. This differential is closely related to assumed growth rates in average earnings and productivity, which are discussed in the previous sections. Over the 40-year period, 1968-2007, the real-wage differential averaged 0.8 percentage point, the result of averages of 0.5, 0.7, 0.8, and 1.4 percentage points for the 10-year periods 1968-77, 1978-87, 1988-97, and 1998‑2007, respectively. The assumed ultimate annual average covered real-wage differentials are 1.7, 1.1, and 0.5 percentage point(s) for the low-cost, intermediate, and high-cost assumptions, respectively.
Based on preliminary data, the real-wage differential is estimated to be ‑1.0 percentage point for 2008. For the intermediate assumptions, the real‑wage differential is projected to rise to 1.8 percentage points for 2009, 2010, and 2011. Thereafter, the real‑wage differential is projected to average the assumed ultimate differential of 1.1 percentage points. For the low-cost assumptions, the real‑wage differential is projected to average 2.3 percentage points for the 2009 to 2011 period, and thereafter to average the assumed ultimate differential of 1.7 percentage points. For the high-cost assumptions, the real‑wage differential is projected to average 1.4 percentage points for the 2009 to 2011 period vary with a second recession and recovery over the 2012 to 2018 period, and average the assumed ultimate differential of 0.5 percentage point thereafter.
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Averageannual wage in covered employment
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The civilian labor force is projected by age, sex, marital status, and presence of children. Projections of the labor force participation rates for each subgroup take into account the percentages of the
population that are disabled or in the military, the levels of Social Security retirement benefits, the state of the economy, and changes in life expectancy. The projections also include a “cohort effect” that applies differences in participation rates for a cohort at a specific age (relative to earlier cohorts at the same age) to participation rates for that cohort at older ages.
The annual rate of growth in the size of the labor force decreased from an average of about 2.1 percent during the 1970s and 1980s to about 1.1 percent from 1990 to 2008. Further slowing of labor force growth is projected due to a substantial slowing of growth in the working age population in the future—a natural consequence of the
baby-boom generation approaching retirement and the succeeding lower-birth-rate cohorts reaching working age. Under the intermediate assumptions, the labor force is projected to increase by about 0.7 percent per year, on average, through 2018. Thereafter, the labor force is projected to increase much more slowly, averaging 0.5 percent over the 2018 to 2050 period, and 0.4 percent over the remainder of the 75-year projection period.
The ultimate projected labor force participation rates are not basic assumptions. They are derived from a historically-based structural relationship using demographic and economic assumptions specific to each alternative. However, the participation rates are not highly sensitive to most of the demographic and economic assumptions. Thus, the projected labor force participation rates vary modestly into the future and across alternatives.
Historically, labor force participation rates have been influenced substantially by trends in demographics and pensions. Between the mid‑1960s and the mid‑1980s, labor force participation rates at ages 50 and over declined for males and were fairly stable for females. These overall declines were facilitated by the large numbers of workers entering the labor force from the baby-boom generation, and from the female population in general, during this period. This increasing supply of labor allowed employers to offer early-retirement options that were attractive. Between the mid‑1980s and about 1995, participation rates roughly stabilized for males and increased for females. Since 1995, however, participation rates for both sexes at ages 50 and over have generally risen significantly, reflecting a decrease in early-out options and relatively strong economic growth.
For the future, changes in available benefit levels from Social Security, increases in the normal retirement age, and the effects of modifying the earnings test are expected to encourage work at older ages. Some of these factors are modeled directly. However, other factors, like the trend away from private defined-benefit pension plans (that often provided incentives to retire) toward defined-contribution plans, are expected to provide additional upward pressure on labor force participation rates. In addition to this shift in private pensions, the aging of the population is expected to both increase the demand for workers and, through improved health associated with greater life expectancy, improve the ability of the older population to work. Longer life expectancy will also increase the amount of assets that will be needed to live comfortably through retirement years, thus encouraging workers to stay employed longer. In order to account for these effects, which are directly or indirectly related to increases in life expectancy, projected participation rates for prime age and older males and females are adjusted upward in relation to assumed increases in life expectancy. For the intermediate projections, this adjustment for changes related to life expectancy adds about 1.4 percent to the total labor force by 2083.
For men age 16 and over, the projected age-adjusted labor force participation rates for 2083 are 72.6, 73.0, and 73.6 percent for the low-cost, intermediate, and high-cost assumptions, respectively, compared to the 2007 level of 73.2 percent. (Age-adjusted labor force participation rates are adjusted to the 2007 age distribution of the civilian noninstitutional U.S. population.) These rates reflect the net effect of increases due to assumed improvements in life expectancy, and decreases due to higher assumed disability prevalence rates and an increasing proportion of males who are never married. For women age 16 and over, the projected age-adjusted labor force participation rates for 2083 are 60.3, 60.4, and 60.3 percent, for the low-cost, intermediate, and high-cost assumptions, respectively, compared to the 2007 level of 59.3 percent. These projections reflect the combination of decreases due to higher assumed disability prevalence rates, increases due to assumed improvements in life expectancy, and increases due to assumed changes in the proportion of females who are separated, widowed, divorced, or never married.
The unemployment rate presented in table V.B2 is in the most commonly cited form, the civilian rate. For years through 2018, total rates are presented without adjustment for the changing age-sex distribution of the population. For years after 2018, unemployment rates are presented as total age-sex- adjusted rates (using the age-sex distribution of the 2007 civilian labor force). Age-sex-adjusted rates allow for more meaningful comparisons across longer time periods.
The total unemployment rate reflects the projected levels of unemployment for various age-sex subgroups of the population. The unemployment rate for each subgroup is projected based on a specification (consistent with Okun’s Law) relating changes in the unemployment rate to the changes in the economic cycle, as measured by the ratio of the actual to potential GDP. For each alternative, the total unemployment rate is projected to move toward the ultimate assumed rate as the economy moves toward the long-range sustainable growth path.
The ultimate age-sex-adjusted unemployment rate for each alternative is assumed to be reached by 2018. The ultimate assumed unemployment rates are 4.5, 5.5, and 6.5 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These are the same values assumed for the 2008 report.
The real growth rate in gross domestic product (GDP) equals the combined growth rates for total employment, productivity, and average hours worked. Total employment is the sum of the U.S. Armed Forces and total civilian employment, which is based on the projected total civilian labor force and unemployment rates. For the 40-year period from 1967 to 2007, the average growth rate in real GDP was 3.0 percent, combining the approximate growth rates of 1.6, 1.7, and ‑0.2 percent for its components—total employment, productivity, and average hours worked, respectively.
For the intermediate assumptions, the average annual growth in real GDP is projected to be 2.4 percent from 2008 to 2018, a slower rate than the 3.0 percent average observed over the historical 40‑year period from 1967 to 2007. This slowdown is primarily due to slower projected growth in total employment. For the low-cost assumptions, annual growth in real GDP is projected to average 3.1 percent over the decade ending in 2018. The relatively faster growth is due mostly to higher assumed rates of growth for employment and worker productivity. For the high-cost assumptions, real GDP is assumed to fall in the third and fourth quarters of 2008 and in the first three quarters of 2009, resulting in a total decline in real GDP for these five quarters of 4.0 percent. After 10 quarters of recovery, a second recession, with a total decline in real GDP of 2.1 percent, is assumed to begin in the second quarter of 2012 and last two quarters. After the second recession, a moderate economic recovery is assumed through 2015, with continued modest economic growth thereafter. For the high-cost assumptions, annual growth in real GDP is projected to average 1.8 percent for the decade ending in 2018.
After 2018, no economic cycles are assumed for the three alternatives. Accordingly, projected rates of growth in real GDP are determined by the projected full-employment rate of growth for total employment, and the assumed full-employment rates of growth for total U.S. economy productivity and average hours worked. For the intermediate assumptions, the projected rate of growth for real GDP falls toward the assumed productivity growth rate because of the projected decline in labor force growth over the period. At the end of the 75‑year projection period, the annual growth in real GDP is 2.1 percent, due to the assumed ultimate percent changes of about 0.4, 1.7, and 0.0 for total employment, productivity, and average hours worked, respectively.
The average annual nominal and real interest rates are presented in table V.B2. The nominal rate is the average of the nominal interest rates for special U.S. Government obligations issuable to the trust funds in each of the 12 months of the year. Interest for these securities is generally compounded semiannually. The real interest rate (ex post) is defined to be the annual compound yield rate for investments in these securities divided by the annual rate of growth in the CPI for the first year after issuance. The real rate shown for each year reflects the actual realized (historical) or expected (future) annual real yield on securities issuable in the prior year.
In developing a reasonable range of assumed ultimate future real interest rates for the three alternatives, historical experience was examined for the 40 years, 1968-2007, and for each of the 10-year subperiods, 1968-77, 1978-87, 1988-97, and 1998-2007. For the 40-year period, the real interest rate averaged 2.8 percent per year. For the four 10-year subperiods, the real interest rates averaged 0.4, 4.1, 4.2, and 2.6 percent, respectively. The assumed ultimate real interest rates are 3.6 percent, 2.9 percent, and 2.1 percent for the low-cost, intermediate, and high-cost assumptions, respectively, and are unchanged from the 2008 report. These ultimate real interest rates, when combined with the ultimate CPI assumptions of 1.8, 2.8, and 3.8 percent, yield ultimate nominal interest rates of about 5.4 percent for the low-cost assumptions, about 5.7 percent for the intermediate assumptions, and about 5.9 percent for the high-cost assumptions. These ultimate nominal rates are assumed to be reached by the end of the short-range period.
The actual average annual nominal interest rate is 4.7 percent for 2007. The annual rate of change in the CPI is assumed to be 4.3 percent for 2008. Hence, the annual real interest rate is 0.4 percent for 2008. For the next 10-year short-range projection period, nominal interest rates are projected based on changes in the business cycle and in the CPI. Under the intermediate assumptions, the nominal interest rate is projected to decline from an actual value of 3.6 percent for 2008 to 3.0 percent for 2009, reflecting a weak economy along with a negative rate of inflation. Thereafter, the nominal interest rate rises to the ultimate assumed level of 5.7 percent for 2018. For the low-cost assumptions, the average annual nominal interest rate is assumed to reach an ultimate level of about 5.4 percent for 2017. For the high-cost assumptions, it is assumed to peak at 8.6 percent for 2014, and then decline to an ultimate rate of about 5.9 percent by 2018.
