Further thoughts on Bank of England’s analysis of QE impacts on savers, pensioners, pension funds and asset markets
by Dr. Ros Altmann
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The Bank of England’s paper for the Treasury Select Committee is an important contribution to the policy debate and worthy of a detailed response. I have summarised here what I see as some very important points that need to be challenged. Obviously there is more work to do, but the Bank’s analysis of its unconventional monetary experiment requires public debate.
The Bank’s assertions are not always backed up with evidence. Indeed, the premise of QE, coupled with the disregard for damage done to older savers and pensioners, are open to question. The real world experience of older generations does not match the Bank’s assertions. A thorough analysis of the distributional impacts of the costs and benefits of QE, and whether these costs and benefits are being borne equitably by different groups of society, is not provided.
Indeed, it is not clear that the Bank’s counterfactual itself, on which many of its assertions are based, is properly specified. The Bank assumes that, in the absence of QE gilt-buying, there would have been no policy stimulus at all. This is simply not credible. There were other options available, and still are, which could have been more effective in boosting growth and employment and could have had far fewer damaging side-effects than QE.
The aim of QE was originally to create inflation (as we were said to be facing deflation). The intention has apparently moved on to trying to boost asset markets (including equities, housing and corporate bonds) – and it is arguable whether this is a central bank’s role.
Certainly, in the face of a flat-lining economy, a banking system that is reluctant to lend as it tries to boost its balance sheets, coupled with overshooting inflation, it is not clear that pursuing more gilt buying is an obvious answer to our economic weakness. I will be preparing more detailed work on investigating QE’s effects, to help put alternative perspectives which policymakers may have missed, but hope you find this note helpful in the meantime.
- Bank assumes QE was only possible way to stimulate growth – that is not the case, there were and are other policy options
- Bank asserts QE has boosted spending – this is not the case for older generations who report cutting back
- Bank says savers have lost £70bn but borrowers have gained £100bn so QE has boosted growth – this ignores demographic distributional effects if savers cut back while borrowers may have repaid debts
- Bank assertion that existing pensioners have not been affected by QE ignores effect of inflation
- In reality, rising personal pension asset values have not offset falling annuity income
- Bank says those hurt by QE when rates fall will then benefit when rates rise over the cycle – this is not true for annuitants or for those whose assets and income are hit by inflation
- Bank has ignored problems for people in income drawdown
- Bank says QE boosted asset prices, helping top 5%, is that its role?
- Bank underestimates QE impact on employer defined benefit pensions
- Bank fails to mention potential problems of unwinding QE policy
MORE DETAILED COMMENT
The Bank’s analysis assumes that QE was the only possible policy to boost the economy but there would have been other options.
Throughout their release, the Bank assumes that if there had been no giltbuying, there would not have been any other policy to stimulate the economy. Of course, buying such a massive amount of Government bonds – £375billion is a huge sum – the policy should have had some beneficial effect on growth. However, the benefits may not be as large as expected. QE assumes sellers of gilts deposit money in banks which can then increase lending to the rest of the economy and stimulate growth. However, we have seen so far that banks with large legacy balance sheet problems cannot in fact be relied upon to pass on the benefits of falling gilt yields and billions of pounds of new deposits to the rest of the economy. Bank lending has not increased, despite all the new money they have received. It is, therefore, possible that alternative policies would have been far more effective in getting money to the parts of the economy that really need it to get growth going, rather than just into banks or institutional asset pools. Buying gilts is a very indirect route to boosting spending and lending and it is not clear just how well the transmission mechanism has been working. Alternatives are gradually starting to be taken more seriously. For example, if new money had been created to underpin small business lending, or even to give some money directly to all households (rather than only those who have large debts, gilt-traders and the wealthiest 5%), or if pension fund assets had been used to develop a national investment fund to boost infrastructure and business lending, then QE might not have been needed and the economy may have been stronger.
Bank says low interest rates have boosted spending – not necessarily true for older generations
The Bank’s analysis asserts that low short-term and long-term interest rates have increased spending in the economy through both income and wealth effects. However, this assertion is open to challenge. In particular, older generations, worried about their future, seeing their incomes fall and trying to live on their savings, worried about how they will afford a comfortable retirement, may actually have been reducing their consumption. Also, pensioners coming up to retirement have found their annuity income is lower than they would previously have expected which has reduced their spending power permanently. Indeed, borrowers who have benefited from low rates may be paying back debt, rather than spending more and those whose house prices are higher than they otherwise would have been due to QE are not necessarily spending any more as a result. The transmission mechanisms for low longterm interest rates to economic growth are not certain and can be different depending on demographics.
Bank says savers have lost £70bn but borrowers have gained £100bn so QE has boosted spending – this ignores demographic distributional effects
The Bank’s analysis concludes that although savers have lost around £70billion of interest income as a result of lower interest rates, this impact is not of particular concern because the loss of income can be offset against the fact that borrowers have benefited by £100 billion as a result of lower borrowing costs. This conclusion ignores the demographic distributional impacts of low rates. The Bank chose to look only at gross savings in aggregate across the economy, rather than analysing the impacts on savers and borrowers separately. Therefore, its conclusion that easier monetary policy has been a stimulus to growth fails to take account of the different age profiles of borrowers and savers – these are not generally the same people. The Bank’s analysis has ignored the fact that most older citizens have low levels of debt and therefore have failed to benefit from lower borrowing (mostly mortgage) costs, while savings income forms a far more important part of over 50s and pensioner incomes. Therefore, while middle and younger age groups may have benefitted from lower borrowing costs in aggregate, these impacts cannot merely be offset against the lower incomes for older age groups to assess distributional consequences.
Bank says existing pensioners have been unaffected but this is not the case because it ignores damage from inflation
The Bank’s initial assertion that QE has not affected existing pensioners can be challenged. The Bank says ‘the pension income of those already in receipt of a pension before asset purchases began has not been affected by QE’. This is not correct, because it fails to factor in the impact of QE on inflation. This omission is odd because the original purpose of easy monetary policies was said to be to fight deflation and ongoing additional QE gilt-buying was justified on the basis that inflation was going to fall well below target. In reality, the Bank’s inflation forecasts have consistently been wrong and it has actually continuously overshot the target. Saga has regularly calculated age-specific inflation figures, which show that cumulative price increases for older age groups have been even higher than for the population as a whole. For example, just since Northern Rock failed, inflation for pensioners has risen by well over 20%. The Bank says that 3 million people have bought annuities in recent years and they will have been negatively impacted by high levels of inflation as their purchasing power has been eroded. QE has reduced real incomes of pensioners already living on annuity incomes, because these pensioners will almost all have bought annuities which have no protection against inflation. Even worse, once they have bought their annuity, it can never be changed, so they will remain permanently poorer for the rest of their retirement.
In practice, it is simply not the case that annuity income falls have been offset by rising pension asset values
The Bank says that increases in pension fund investment values have offset the fall in annuity income caused by lower gilt yields. This is not the real-world experience of most people coming up to retirement. In fact, their pension funds have performed poorly in recent years, while annuity rates have consistently fallen over time, irrespective of how equities have performed. Typical private pension funds have failed to keep up with falling annuity rates in the real world, even if the Bank suggests they should have done. For example, since July 2007, the FTSE index has fallen by over 10%, and annuity incomes have fallen by nearly 25%. Over the past year, since July 2011, the FTSE index has fallen by around 2.5%, and annuity income has fallen by over 14%. So the Bank’s conclusion that ‘QE is estimated to have had a broadly neutral impact on the value of the annuity income that can be purchased from a typical personal pension pot’ does not fit with most pension savers’ experience. Timing effects are of over-riding importance, since an annuity is a one-time purchase which means selling all the pension assets at one point in time and then buying an income at that same time. The Notes show tables of annuity and gilt rates and equity market performance and show that equity markets have been very volatile, while annuity rates have been moving more in one direction. Many pensioners have lost out due to having to buy their annuity when the markets were in a difficult phase.
Bank says negative effects of QE on savers or pensioners will be reversed as interest rates rise, but this is not so for those who bought annuities
The Bank’s analysis does mention the distributional consequences of lower interest rates, and possible damage to incomes of those relying on savings or pensions, but says that these effects will typically balance out over the course of a policy cycle, so it fails to factor them in seriously. Unfortunately, this theoretical justification does not apply in the real world. Any pensioner who has bought an annuity when interest rates are at current artificially low levels will never benefit when rates go back up again. The damage done by inflation is also a permanent reduction in pensioner spending power for those who are retired. If and when rates do rise in future, the beneficiaries would include insurance companies who sold annuities at current low rates and wealthy pensioners who could afford not buy their pension income at the moment.
Bank has ignored problems for people in income drawdown
The Bank’s analysis has failed to look at the impact of QE on those pensioners who have not bought annuities, but have income drawdown policies. Over 300,000 people have drawdown policies whose incomes have been squeezed by QE, due to reductions in the amounts they are allowed to withdraw from their own pension funds each year. These amounts are set by the Government Actuary’s Department and reflect gilt yields. The lower gilt yields go, the less income the Government allows people to withdraw from their fund.
Bank says QE has boosted asset prices, but in fact this helps top 5% most
The Bank claims that its policies have pushed up asset prices, which has therefore benefited the economy in general and pensioners in particular. One has to question the wisdom of a central bank claiming to want to directly influence equity markets and artificially distort the supposed-to-be risk-free assets that underpin other private financial markets. In fact, it also shows that it is mainly the wealthiest 5% of the population who directly benefit from higher asset prices. Most people rely more on ordinary savings, or annuities and middle class savers have seen a significant fall in their nominal savings and annuity income. Their real incomes have also been squeezed by higher than predicted inflation. These impacts have affected millions of older people but are being ignored by the Bank’s analysis.
Bank has dangerously downplayed QE impact on employer defined benefit pensions
The impact of QE on final salary pension schemes – and on the companies responsible for them – has been severely underestimated. It is certainly not the case, in practice, that the performance of pension fund assets has offset the fall in liability discount rates. The theoretical arguments used to deny that QE has caused significant pension damage do not really fit with the real world. The Bank suggests that pension funds without deficits at the start of the financial crisis would not have been impacted by QE at all because if they were fully funded, their asset values would have risen in line with the rise in liabilities. It does admit that this requires funds to be holding gilts and bonds that are used to discount their liabilities, which of course pension funds in the UK do not normally do. Indeed, the only pension funds that would not have suffered a fall in funding since QE started would be those which had already bought their annuities. However, this is not how pension funds have worked in the real world. Firstly, almost all final salary schemes have been in deficit for some time, and indeed it is those with deficits that we need to be most concerned about when considering the economy. Secondly, almost no pension schemes hold only gilts – and in any case gilts do not match pension liabilities properly, so a scheme that held only gilts would still have fallen into deficit due to rising life expectancy and inflation and duration mis-matches.
More importantly, however, the Bank should have considered the fact that most UK schemes are indeed in deficit and, therefore, that buying so many gilts would in reality cause a significant rise in scheme deficits. The practical result of this is that firms struggling to fund their pension deficits cannot invest in their business, cannot create jobs and in some cases are even failing. In fact, more recently, banks are now increasingly unwilling to lend to companies with deficit problems. This negative impact of QE has not been taken sufficiently seriously, but it is obviously going to harm growth and employment. The problem of pension deficits is a direct result of QE gilt-buying. The further problems arise because firms are stuck with their deficits and, as QE has also increased the costs of buying annuities, companies cannot find a way out of the problems. If the trustees buy more gilts in order to try to ‘reduce risk’ as their deficit grows, this competes with Bank of England gilt purchases, which drives the price of gilts up even more and thus increases the deficits even more! As the Bank itself is buying the assets that pension funds would normally need to help manage their deficits, or buy out their liabilities, QE is damaging many UK companies who, despite putting billions into their pension schemes, still find their deficits have grown.
There is no mention at all of what will happen when the Bank needs to unwind its QE policy
It is very worrying that there is no mention in this paper of the possible negative consequences of having to sell the gilts it has purchased. Surely, the result is that long-term interest rates will rise, asset markets will be more vulnerable to downside risks and ultimately markets may be negatively affected.
Dr. Ros Altmann
TABLE SHOWING CHANGES IN ANNUITY RATES, GILT YIELDS AND STOCK MARKET SINCE 2007
|FTSE||15 yr gilt yields %||Annuity rates %|