Put simply, if interest rates fall, then a pension fund needs a bigger pool of assets to meet its future obligations. But if its liabilities are matched by a combination of gilts and equities, the increase in the value of those assets as interest rates fall is broadly similar to the increase in liabilities. The capital gain offsets the impact of the lower level of interest rates, leaving the net position of the pension fund broadly unchanged.
Where QE has caused difficulties is for those defined-benefit pension schemes that were already in substantial deficit. In this case, QE is likely to have increased the size of the deficit.
Although QE raised the value of the assets and liabilities by a similar proportion, if the liabilities were greater than the assets to start with, this would have led to a widening in the gap between the two.
But even in this case, the burden of these increased deficits is likely to fall on the company’s shareholders and future employees, rather than those nearing retirement.Please re-read the highlighted text as Mr. Dale explains how QE triggers the Pension Death Spiral.
The Pension Death Spiral refers to the economic doom loop caused by the transfer of resources from the real economy to support the pension funds.
Specifically, as interest rates decline, the company now has to make up the shortfall. It does this by transferring money that would otherwise be reinvested in the business. This transfer of money reduces economic growth which in turn restarts the cycle as interest rates are kept low which in turn requires more money be transferred to the pension fund and away from growing the real economy.
The same downward spiral applies to future employees. If the burden of making up the pension shortfall is their problem, they reduce their current consumption in order to save for retirement. The bigger the pension burden, the bigger the drop in current consumption. Again, the real economy is subject to an economic doom loop.
Our economy is still labouring under the effects of the financial crisis. The task for monetary policy is to stimulate the economy and return it to a path of stable growth, low inflation (and a more normal level of interest rates). That will be for the good of everyone in our society.So the question is, when will the central bank start pursuing policies to stimulate the economy and return it to a path of stable growth by raising interest rates?