IMF is right we need ‘Plan B’ – but more QE gilt-buying is the wrong answer
by Dr. Ros Altmann
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Undermining UK pensions is not a recipe for economic recovery
The IMF has rightly called on the UK to introduce a programme to boost growth and jobs. But it wrongly suggests that more QE would achieve this. In fact, by continuing to buy gilts, the Bank of England would more likely damage growth than boost it.
Economists seem to be living in an academic parallel universe that is ignoring reality. Quantitative Easing has not created jobs so far and, by damaging UK pensions as a whole, it is not necessarily a boost to growth in our aging population. Fiscal policy has run out of room and monetary policy has also failed, we need new thinking.
QE has been a disaster for anyone recently or soon-to-be retired, except those who have final salary-type pensions. It has also been a disaster for employers running defined benefit pension schemes , as employers are picking up the extra costs of pensions that have resulted from QE gilt-buying. Bank of England gilt purchases have driven down gilt yields, with each 1% point fall adding around 20% to pension liabilities. Since 2008, 15-year yields have fallen by 2½ percentage points, so liabilities have risen by 50% – while assets have certainly not risen by anything like that amount. Therefore, QE has caused final salary scheme deficits to rise sharply, forcing firms to invest in their pension funds, not their businesses, which weakens growth – and indeed some companies have been forced into insolvency due to their pension deficits, thereby destroying jobs.
UK pensions are also unusually dependent on gilt yields, since most people retiring with defined contribution pensions (personal pensions, stakeholder pensions and other non-final salary-type schemes) buy annuities to secure their pension income. Lower gilt yields mean lower annuity rates. Anyone who bought an annuity in recent years at artificially depressed rates resulting from QE will be permanently poorer for the rest of their lives. Nearly half a million people every year are buying an annuity, which is a one-off irreversible purchase, so already QE has permanently impoverished over a million pensioners for the rest of their lives. This harms long-term growth, as well as short-term confidence and, even worse, most people buy an annuity without any inflation protection, so they will gradually become poorer each year.
In theory, creating billions of pounds to buy Government bonds is supposed to boost growth and create jobs. In practice, this is not what is happening. The Bank of England and IMF believe that buying gilts boosts the economy and increases asset prices, but in the world of financial reality, sellers of gilts are not switching their money to other assets in the UK. They may be buying overseas bonds, overseas equities, commodities or financial derivatives. None of this will directly stimulate the UK economy – but it does help bank trading profits. QE also relies on banks to transmit the newly created money to other parts of the economy that could create growth, but this is just not happening – and clearly cannot be relied on.
It is time to consider whether we need to accept that QE has failed or, at the very least, has no more mileage from such low levels of gilt yields. Buying gilts does not directly stimulate the economy.
Yes, the IMF is right that we need to boost infrastructure spending and help lend to smaller companies to create jobs. But that will not be achieved by QE gilt-purchases.
If the Bank creates more new money, it should be used to underpin large construction projects funded by pension investors, or to underwrite losses on loans to small firms that would directly create jobs.
The IMF and Bank of England are risking repeating the crisis of 2008 by dangerously distorting the gilt market. Not only does this risk creating a new financial bubble that seems great in the short-run but could be disastrous when it burst, it also undermines our pension system and has side-effects that actually damage growth – both short-term and long-term.
Academic models are not working in the real world. With our aging population and pension system that is underpinned by gilt yields, the medicine is doing more harm than good. If we want to create jobs, we must take a new approach. Fiscal policy is constrained by past spending, but there are billions of pounds in pension funds that could be harnessed to boost growth. We don’t need to create new money to monetise the budget deficit, we can’t rely on the banks to revive lending and construction. We need to create new money to directly help the economy. The sooner the Bank faces up to this reality, the better.