British savers and pensioners are among the biggest losers from the Bank of England’s long-running programme of quantitive easing. This is because the main way QE affects the economy is by holding long-term interest rates below market levels. Annuities are based on long-term rates and, for a 65-year-old man, the income from an average annuity fell by almost 12 per cent in 2012.
The Bank has claimed that such loss of retirement income is offset by the stimulus QE provides to the stock and bond markets in which pensions are invested. However, the extent of this offset is limited for funds that are in deficit and for many people with personal pensions and savings who have been advised to shift their resources out of volatile assets and into fixed-interest accounts. Retirees and others who are living off their savings will continue to suffer financial repression as long as interest rates are held down. They receive a double whammy if inflation remains high, pushing real interest rates further below zero.
Fortunately there is an easy and politically attractive way that the chancellor of the exchequer could counteract this negative byproduct of QE. In his next Budget he could instruct National Savings and Investments to issue an inflation-linked “pensioner bond” available for purchase only by individuals over 60 or for younger people within their pension wrapper to grow in value until they retired. Institutional pension providers would not be eligible as purchasers. The real interest rate could be fixed at 2.5 per cent, the current estimate of the economy’s potential growth rate, plus recorded inflation over the previous 12 months, as measured by the consumer price index.
With inflation today standing at 2.7 per cent, these pensioner bonds would have a highly attractive yield of 5.2 per cent compared to less than 1 per cent on most savings accounts. To avoid giving an extra advantage to those in high tax brackets, interest payments would be taxed as income when received and total purchases could be capped at, say, £100,000 a person. This would be high enough to meet the needs of most savers but not so high as to crowd out the bulk of other investments in the personal pension pots of wealthier people.
The advantages of such a proposal are that it is easily understood; it could be closely targeted as it is based on age and already defined pension wrappers; its impact on the public finances would be minimal because of its targeting and it would reinforce the incentive to save for retirement rather than relying on the state. The disadvantages are that it could divert savings from alternative investments – which the financial services industry would not like – and it would cost the Treasury more to fund a portion of its debt as market rates on inflation-linked government bonds have recently fallen below zero. This extra cost to the exchequer could be limited by capping the size of individual holdings of pensioner bonds.
There could also be an unexpected macroeconomic benefit. The over-60s account for a growing share of the total population and they are generally net spenders, not savers. They own more than a quarter of household wealth in the UK and naturally they are concerned about its erosion through inflation or market turbulence. Providing them with the security of a known, inflation-proof income could stimulate their spending on leisure services such as travel and entertainment. Among Japanese economists there has long been a renegade school of thought that low interest rates for long periods have depressed, rather than stimulated, consumption because of the high proportion of older households who base their spending on interest income. If this is even partially true, then augmenting today’s low interest rates for younger borrowers with high rates for older savers could provide a new “operation twist” to complement the monetary policy stimulus from QE.
This commentary appeared in The A-list blog on FT.com on 16th January 2013