The Automatic Stabilizing Effects of Social Security and 401(k) Plans

This study assesses the role of Social Security (OASI) and Social Security Disability Insurance, 401(k) plans, unemployment insurance, Medicare, and the federal income tax system in moderating the business cycle in the United States. Using Instrumental Variable (IV) estimation, we demonstrate that 401(k) plans exhibit a destabilizing influence in the economy. In contrast, Social Security, especially the Old-Age Survivors Insurance (OASI) program, reacts counter-cyclically and therefore has a positive effect on macroeconomic stabilization. Comparing the automatic stabilization properties of Social Security and 401(k) with those of conventional stabilizers – federal income tax, unemployment insurance, disability, and Medicare 401(k) -- reveals that 401(k) accounts reduce the automatic stabilization properties of these government programs by up to 20 percent. Policy makers must consider this unintended macroeconomic effect before expanding individual financial accounts for the purpose of funding retirement income.