FT Comment piece – Better ways out of this crisis
by Dr. Ros Altmann
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Policymakers are desperately trying to boost the flagging economy. Huge rate reductions and a small VAT cut are supposed to encourage more spending, lending and borrowing, to fight the spectre of depression. Sadly, such desperate measures are misguided. They also ignore the looming demographic dangers which will inevitably hamper future growth.
Dramatic rate cuts make strong headlines and are easy to implement. However, lower rates are a very crude weapon and entail significant collateral damage. Indeed, this supposedly ‘expansionary’ policy may actually worsen the recession as emergency action can cause normal economic relationships to break down.
Panic measures undermine confidence as people reduce spending and retrench, fearing worse to come. This negative effect far outweighs the possible positive impact of encouraging already over-indebted consumers to borrow and spend more. And lower rates are not guaranteed to boost lending. Lenders have increased margins, and raised loan charges, meaning businesses and households are still struggling with both the availability and affordability of credit.
Policymakers have not given previous cuts sufficient time to take effect. Monetary policy operates with a lag. If patients fail to show early signs of recovery, sensible doctors will either give the medicine time to work, or change treatment, rather than desperately doubling the dose. An overdose could even prove fatal. The same may apply to rate cuts, however frustrating that might be for authorities desperate to ‘do something’!
Consensus fears of deflation are also overdone. Falling prices are a statistical inevitability after the sharp increases in 2008, but this does not necessarily mean depression, it could well just be a temporary phenomenon. In reality, inflation is a far greater danger.
I believe politicians have already decided that inflation offers the least painful way to repay debts in the medium-term. Monetary policy is now endorsing that. Another few months of severe economic pain are inevitable. But the financial sector will remain weak for far longer and will fight hard to retain overly easy monetary conditions, even when that would not be appropriate for the rest of the economy. Politically it will prove almost impossible to resist such pressure.
This bodes ill for our ageing population. So far, policy has helped debtors too little but has also damaged creditors too much.
Savers, particularly pensioners, have lost substantially. Rate cuts represent a tax increase for pensioners; like cutting the state pension, this is not expansionary. Millions of pensioners have seen their incomes slashed. If half of Britain’s 12 million pensioners have £20,000 of savings, recent rate cuts imply £20 a week less income, which is £5billion a year.
Disgracefully, pension credit means-tests still assume pensioners are earning 10% (yes, 10%) interest on their savings. This pushes more into poverty, is socially reprehensible and damages consumption.
Quantitative easing, such as buying long gilts, could also be counter-productive. It would damage pension funds and insurers are already struggling with soaring liabilities. Government should actually take advantage of current exceptionally low yields to issue more paper before the gilt ‘bubble’ bursts. Why not issue special pension or annuity gilts? Hundreds of billions of pounds of long duration, limited price inflation and perhaps (at last) longevity/mortality gilts, could be sold to willing domestic buyers. This would also reduce reliance on overseas investors financing ballooning fiscal deficits.
Policymakers must think through some of the longer-term issues. This crisis was caused by excessive focus on short-term growth and misunderstanding of financial risk. Debtors, particularly those who were highly leveraged, cannot service their debts. Many banks are truly bust. Encouraged by abnormally attractive financing arrangements, lax regulation and complex risk models that failed to properly reflect risk, financial institutions have lent, borrowed and invested irresponsibly. Most Western economies have been living beyond their means for several years, effectively borrowing money from the future.
Demographically, this is a disaster. Dramatically falling birth rates after the post-war baby boom mean insufficient younger cohorts to produce future growth. Yet they will shoulder the repayment burdens as millions of those older workers are about to leave the labour force. Increased borrowing will worsen the payback problems.
Yes, fiscal expansion is needed, such as reintroducing the 10p tax rate or temporarily lowering national insurance, rather than the ineffectual VAT cut. However, it is essential to cut wasteful public spending and run a tighter ship, notwithstanding vested political and union interests. We also require urgent radical reform of both pensions and retirement to cope with demographic drag. Government should take charge, organise direct lending to viable private businesses, and resist aggravating the coming inflationary crisis via more damaging rate cuts or monetary easing.