IB#2  

Introduction

Over the long term, stocks have earned a higher rate of return than Treasury bonds. Therefore, many recent proposals to reform Social Security include a stock investment component. In evaluating these proposals, the Social Security Administration’s Office of the Actuary (OACT) has generally used a 7.0 percent real return for stocks (based on a long-term historical average) throughout its 75-year projection period. For the return on Treasury bonds, it currently assumes some variation in the initial decade followed by a constant real return of 3.0 percent. Therefore, its current assumption for the equity premium, defined as the difference between yields on equities and Treasuries, is 4.0 percent in the long run. Some critics contend that the projected return on stocks ¾ and the resulting equity premium ¾ used by the OACT are too high...

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Peter Diamond is an Institute Professor at the Massachusetts Institute of Technology. The author is grateful to John Campbell, Alicia Munnell and Jim Poterba for extended discussions and to Andy Abel, Dean Baker, Olivier Blanchard, John Cochrane, Andy Eschtruth, Steve Goss, Joyce Manchester, Peter Orszag, Bernie Saffran, Jeremy Siegel, Tim Smeeding, Peter Temin and Joe White for helpful comments. The views and remaining errors are those of the author.