Retirement Implications of a Low Wage Growth, Low Real Interest Rate Economy

40 Pages Posted: 19 Feb 2019 Last revised: 1 May 2021

See all articles by Jason Scott

Jason Scott

Independent

John B. Shoven

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Sita Slavov

George Mason University - School of Policy, Government, and International Affairs

John G. Watson

Stanford Graduate School of Business

Date Written: February 2019

Abstract

We examine the implications of persistent low real interest rates and wage growth rates on individuals nearing retirement. We begin by reviewing the concept of r star – the long-term real, safe interest rate that is neither expansionary nor contractionary – and presenting recent estimates suggesting that this value has declined. We then examine the implications of low returns and low wage growth for individuals currently aged 45 and 55. We find that low returns and low wage growth have substantial welfare effects, with compensating variations that are often in the hundreds of thousands of dollars. Low returns increase optimal Social Security claiming ages and the marginal benefit of working longer, while low wage growth decreases the marginal benefit of working longer. Low economy-wide wage growth has a much larger welfare effect than low individual wage growth due to wage indexation of the initial benefit and the progressivity of the Social Security benefit formula. When individual wage growth alone is low, wage indexation is unchanged, and the progressivity of the benefit formula provides insurance. When economy-wide wage growth is low, wage indexation is less generous and there is no insurance benefit from progressivity as average wages fall along with individual wages.

Suggested Citation

Scott, Jason and Shoven, John B. and Slavov, Sita and Watson, John G., Retirement Implications of a Low Wage Growth, Low Real Interest Rate Economy (February 2019). NBER Working Paper No. w25556, Available at SSRN: https://ssrn.com/abstract=3336508

John B. Shoven

Stanford University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Sita Slavov

George Mason University - School of Policy, Government, and International Affairs ( email )

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John G. Watson

Stanford Graduate School of Business ( email )

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Stanford, CA 94305
United States

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