UK Interest Rates
Janet Yellen opened the festivities at this year’s Jackson Hole economic symposium by musing on what central bankers had learned since the crisis and how they can deal with future recessions in a world where interest rates are far lower than in the past. Unsurprisingly, bond-buying and “forward guidance” featured prominently in Yellen’s narrative of successful new tools. (On the other hand, scholars have estimated the combined impact of these measures was an unemployment rate a mere 0.13 percentage points below where it would have been using purely conventional instruments.)
This is a guest post from Richard Koo, chief economist of the Nomura Research Institute and, amongst many other things, author of “The Holy Grail of Macroeconomics, Lessons from Japan’s Great Recession”, which lays out his balance sheet recession thesis in detail. The post is an updated extract from his most recent note for Nomura and reproduced here, with his permission, for your arguing pleasure… The US, the UK, Japan, and Europe all implemented quantitative easing (QE) policies, but the understanding of how those policies work apparently differs greatly from country to country, leading to very different outcomes. With the US economy doing better than the rest, there has been some debate in Europe as to why that is the case.
Here’s an odd argument the Bank of England is somehow to blame for BHS’s massive pension hole. This is the key bit: The investment environment fundamentally changed post-2008. To keep the UK economy liquid in the crisis, between August 2008 and March 2009, the Bank of England cut the base interest rate from 5% to a record low of 0.5%, where it has stayed ever since…The problem arises in the difference between the amount of money set aside to cover eventual pensions and the obligations. The entire DB scheme is a bet that today’s investments will always come good, forever, and cover tomorrow’s guaranteed payments. Schemes had been banking on annual returns from their investments of at least 5%. Suddenly, with low interest rates, and stocks going through the post-crisis trough, it’s down to 0.5% as a base. That means they have to put up a lot more new money to get the returns they need. Contrary to what’s implied in the piece, it’s quite simple to manage a defined-benefit pension properly — especially if most of the beneficiaries are already retired. The level of interest rates only matters if you’re doing it wrong.