Tuesday, January 29, 2013

Pension experts: QE is a 'monumental' mistake

The Guardian reports that pension experts have gone before a Parliament committee and explained why the Bank of England's pursuit of quantitative easing (QE) has been a 'monumental' mistake and how the economy would recover if the BoE stopped pursuing all the related low interest rate policies.

Regular readers of this blog will be familiar with the arguments that the pension experts put forward on why QE should be abandoned as they were presented here first.

The Bank of England's policy of pumping money into the economy has been a "monumental mistake", pensions experts have warned . 
A committee of MPs heard that measures taken by the Bank to drive the economy had backfired by squeezing individuals' incomes – both pensioners and those in work – and forcing companies to divert cash into pension funds rather than investing.
I referred to these two economic headwinds as the retirement fund death spiral.  The trigger for the death spiral is the adoption of zero interest rate and related policies like QE.

Both individuals and companies move to offset the loss of earnings on their savings and reinforce the negative feedback loop.  Individuals do this by cutting back current consumption and saving more.  Companies offset the decline in earnings on pension funds by diverting cash rather than investing.

The actions by both individuals and companies reduce aggregate demand.  Since the BoE wants to boost aggregate demand, it pursues the low interest rate policies even more aggressively.  The result is a further drop in aggregate demand as both individuals and corporations move to offset the loss income.

That individuals change their spending and saving habits in the face of low interest rates has been known since the 1870s.  Walter Bagehot, the father of modern central banking, even stated that interest rates should never be less than 2%.
Ros Altmann, pensions expert and director general of Saga, said current policies devalued pensioners' incomes, making them less willing to spend: "Quantitative easing and ultra-low interest rates have hampered the spending power of those in the economy who were not over-indebted and who would otherwise have spent money." ...
Altmann said ending the QE programme was much more likely to herald a period of growth than its introduction had done. "History will judge this as a monumental mistake," she said. "If we do not have any more quantitative easing, the economy will be freer to grow than if we do."
Please re-read the highlighted text as Ros Altmann has nicely summarized what your humble blogger has been saying about why zero interest rate policies never work to boost demand and why abandoning these policies would actually produce the growth in the economy that central bankers want.
Under the QE programme, the Bank of England has bought £375bn of UK government bonds, or gilts, with newly created electronic money. It now owns almost a third of all gilts in the market. This huge influx of demand has driven gilt prices higher and means yields, or the effective interest rates on them – which represent government borrowing costs – are at record low levels. 
That has the unintended consequence of pummelling pension funds, which use gilt yields to calculate their future liabilities. When gilt yields plummet, pension fund deficits effectively balloon. 
The National Association of Pension Funds (NAPF) estimated last year that QE had increased pension deficits by at least £90bn over the past three years. 
Current regulations mean companies must plug those holes. Mark Hyde Harrison, the chairman of NAPF, said businesses are now having to contribute to their pension schemes instead of investing for the future, which negates any positive impact of QE....
Please re-read the highlighted text as Mr. Harrison has described the retirement fund death spiral triggered by zero interest rate policies.
QE has also reduced the incomes of recent retirees using their pension pot to buy an annuity, which sets the size of their income for life, as annuities are also linked to gilt yields. 
Altmann said monetary easing had acted like a "tax increase" on older people. She said the economy is in "unprecedented territory" and the gilt market had never been distorted in such a way. 
The Bank of England had not properly considered whether carrying out a policy which penalises certain sections of society is acceptable, because it has assumed that the path it has taken was the only option. 
QE is not creating growth and is hampering the spending of people who are not particularly burdened with debt because they are "worried about what's coming next," she said.
Please re-read the highlighted text as Ms. Altmann has made a very important point.  Specifically, the pursuit of zero interest rate policies including QE sends a message that undermines consumer confidence as these policies reflect the simple fact that central banks are still in crisis management mode.

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