Prescott, Time Inconsistency, and Social Security
By Arnold Kling
Nobel Laureate Edward Prescott thinks that we need mandatory saving to solve a time inconsistency problem.
The reason we need to have mandatory retirement accounts is not because people are irrational, but precisely because they are perfectly rational — they know exactly what they are doing. If, for example, somebody knows that they will be cared for in old age — even if they don’t save a nickel — then what is their incentive to save that nickel? Wouldn’t it be rational to spend that nickel instead?
The time inconsistency problem is that the government will tell people that they need to use their own savings for retirement, but then change its mind when it sees that people are destitute. Mandatory savings accounts are the solution.
Prescott makes the following rhetorical argument about Social Security reform:
if we could wipe the slate clean, what kind of government retirement program would we build from scratch today? …I’m willing to bet that the best minds of both political parties, given such a charge, would not come up with a government retirement program as it currently exists.
For Discussion. If we could wipe the slate clean, would the best minds tend toward private mandatory savings accounts with restrictions on the instruments that could be used as investment vehicles?