Carney and the death of unreasonable expectations
Yesterday, Mark Carney, the new Governor of the Bank of England, announced that there would be no rise in the Bank of England's base rate until unemployment (currently about 8%) is below 7%. At its current rate of fall, this wouldn't be expected until the back end of 2016. So if there is no improvement in the UK economy, UK interest rates are expected to remain very low for the next three years.
Predictably, there was a storm of outrage from savers and their representatives. This tweet is typical:
I don't think it is. But to explain why, I need first to explain what inflation is.
In an economy where the money supply adjusts to economic needs*, the inflation rate is a measure of the excess of aggregate demand over aggregate supply. It is healthy for an economy to have a small excess of demand over supply, as it gives an incentive to producers to produce and consumers to consume: persistent disinflation is economically damaging, as the tendency of consumers to delay spending in the expectation that prices will fall reduces sales, depresses business income and can drive producers out of business, causing fire sales and layoffs, leading to more delayed consumption and further price falls - it is all too easy to see how this can become a deflationary spiral. But a positive inflation rate, even a small one, means that savers suffer erosion of their capital over time. The interest rate on savings is a compensation for that loss.
In an open economy, the inflation rate is not always a good indicator of domestic aggregate demand. It may indicate the extent to which demand for goods (especially commodities) in the international marketplace exceeds supply, and that affects the cost of domestic production, driving up prices to consumers especially for essential goods such as food and energy. It may also indicate fiscal tightening, as rises in indirect taxes such as VAT increase headline CPI. And it may indicate that the international purchasing power of the currency is reduced (devaluation): sterling has devalued by about 25% since 2008. The inflation rate for consumers can therefore be higher than the actual productive capability of the economy. This is what is happening in the UK at the moment. Inflation is running above target, at about 2.9%, mainly due to price rises in imported goods (notably fuel), which are partly due to the low pound (larger image here):
But the economy is growing at much less than this. Estimates vary as to the GDP growth rate at the moment but the last figure from ONS was 0.6%, which is just above the Bank of England's base interest rate, and economic growth has been hovering around zero for the last three years (larger image here):
This is dismal. It is stagnation, not growth.
So why shouldn't savers be protected from the capital erosion caused by inflation?
There are three categories of savers:
The second of these involves the largest number of people, though perhaps not the largest amounts of money. These are people saving for retirement and for unexpected future expenses. The savings are long-term - often 30 years or more. Now, I've noted already that it is healthy for an economy to have a small positive inflation rate. Given that for savers to have a return on their savings AT ALL requires a healthy economy, I don't see any reason for savers to expect to be compensated for the natural erosion of purchasing power that exists in a healthy economy. It's a necessary cost of saving. They just need to save a bit more to allow for it, that's all. Alternatively, if people feel strongly that they should be compensated for inflation, index-linked investment products are available for longer-term savings. They will pay a bit more for them, but their capital will be protected.
But what if inflation is higher than the amount needed to keep the economy humming along? Shouldn't savers expect to be compensated for this? Not necessarily. We would normally expect that higher inflation would cause interest rates to rise, which compensates savers for the greater loss of purchasing power. Raising interest rates increases the cost of finance for businesses and households, which causes them to defer business investment and consumer spending. In an economy that is experiencing inflationary pressures due to fast growth, this is a good thing: but for an economy that is stagnating, businesses deferring investment and consumers deferring spending is disastrous. This is why "stagflation" - the combination of high inflation and a stagnating economy - is so poisonous. Raising interest rates to choke off inflation destroys desperately-needed economic activity, delaying recovery. And stagflation accurately describes the current state of the UK economy.
The desire of savers to be compensated for loss of purchasing power is understandable but wrong. The risk-free rate of return is related to the growth rate of the economy, not the inflation rate. Savers have no right whatsoever to expect to receive a higher rate of return than the ability of the economy to generate that return. If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that. If savers want higher returns they have to put their money at risk.
At the moment savers have unreasonable expectations. They expect to have returns on their savings far above the current level of economic growth, and they also expect to have their savings protected from loss. But the only way savers can have risk-free returns above the growth rate of the economy is by others - most likely government - taking on debt. It's rent-seeking, frankly. I find it extremely odd that the same people who clamour for higher interest rates for savers are also those who shriek about the deficit and warn about the dangers of high levels of government debt. They clearly don't understand that higher interest rates for savers in the present climate means a larger government deficit because of increased cost of interest service on risk-free investments (government bonds). Or if they do understand, they don't care.
And while I'm at it, I shall criticise those who want higher interest rates on bank deposits, too. Bank funding costs have a direct bearing on the cost of finance to the wider economy. Interest rates for SMEs are already cripplingly high despite bank funding rates being low. If interest rates on deposits rise, what do you think will happen to interest rates for the small businesses that we so desperately need to encourage? Really there is a logic fail here. In calling for higher interest rates, savers are effectively demanding that there should be no recovery. And in killing off such unreasonable expectations, Carney is doing us all a favour.
What we need is for savers to take risks with their money. Now there is a bit of a problem here, I agree. The "reach for yield" in capital markets caused by low interest rates and excess liquidity is leading investors to switch into all manner of high-risk investments, such as sub-Saharan government debt. I regard this as excessively risky to the point of imprudence and it is NOT what I mean by savers "risking their money", any more than I would recommend that they blow it all at Aintree or on the casinos in Las Vegas. When I say I want savers to "risk their money", I mean productive investment in their own economy for a future return - for example, in the small businesses I mentioned above. I would like to see government, including local government, issuing bonds to savers to finance long-term infrastructure and energy projects. I would like to see expansion in local investment banks and credit unions providing finance to small businesses. And I'm very encouraged by the growth of internet providers such as Funding Circle and CrowdCube bringing together small investors and businesses who need finance, crowdsourcing both debt and equity.
Obviously there are some people who need their savings to be as close to risk-free as possible - "rainy day" savings for example. I think there is a role for government in providing genuinely risk-free savings opportunities for those who need them, and recycling the funds into the economy via a State Investment Bank. But these savings, and other protected savings such as insured bank deposit accounts, should only bear the risk-free interest rate.
I've heard it argued that interest rates on savings should actually be above inflation because savers expect to be compensated for their decision to defer consumption into the future. I'm afraid I think this is utterly bonkers.Whatever the reason for saving, it gives current benefits (in econospeak, "utility") as well as future ones. If your reason for saving is to avoid paying the interest on debt, then there is satisfaction from knowing that the interest cost is avoided - and there may also be a moral satisfaction from having "saved up" for something. If your reason for saving is to insure against future loss of income, you will derive comfort from knowing that your future is secure. And if your reason for saving is that you already have four yachts, sixteen cars and a house on every continent and you can't think of anything to buy, well frankly I don't see why you should be compensated for the fact that you have more money than you know what to do with. Do something useful with it. Invest it in a small business. Give it to someone who needs it. Spend it on desperately-needed medical supplies in a poverty-stricken country. Get some "utility" from using your money to help others. You don't need it, you can't take it with you, and you certainly don't need compensation for not spending it. Really.
And finally. I really don't hate savers, but I do think they need to be more reasonable. And I do have some sympathy for those who expected to use the income from their savings to top up their state pensions, and are feeling the pinch because that income is much reduced. However, the idea that these are "poor pensioners" is wide of the mark. The majority of pensioners live on the basic state pension and additional benefits, and they are not affected by this. The pensioners who are feeling the pinch are the better-off ones, the ones who have corporate and/or personal pensions and maybe other savings too in addition to the state pension. So I'm not impressed with the "poor pensioners" argument. The poor pensioners are those getting by on the basic state pension. This lot are poorer than they expected to be, but compared with the majority of pensioners they are not poor. And I have to ask why people who are living on unearned income from savings should have their incomes protected when people who are living on earned income - many of whom are too poor to save for retirement - do not. The people who have seen the largest falls in their real incomes in the last five years are not people living on unearned income (savings or benefits), but people who are working for their living. When will I see some concern from savers - or more accurately, their representatives - for the people whose incomes are being squeezed by unemployment, under-employment, falling wages, inflation, tax rises and benefit cuts?
Related reading:
(heavens, all of it Scripture-based!)
The golden calf - Coppola Comment
The foolish Samaritan - Coppola Comment
The parable of the rich fool - Luke 12:13-21, NIV
Added 10th August 2013:
The symbolic importance of NOT raising interest rates - Tomas Hirst (Pieria)
* In an economy where the nominal amount of money in circulation is fixed - such as a strict bullion gold standard - it is normal for prices to fall over time (disinflation) if the economy is healthy, since economic growth coupled with a fixed money supply causes the purchasing power of money to increase.
Predictably, there was a storm of outrage from savers and their representatives. This tweet is typical:
What Mark Carney said today is "Savers, I will continue to STEAL your money, as Mervyn King did", for the chancellor. #newsnightThe idea that very low interest rates is "stealing" from savers is based on savers' expectations that: their capital will be protected from inflation. UK CPI is indeed running above the interest rates on most forms of savings, so savers are losing money as the purchasing power of their capital is eroded. But is it reasonable for savers to expect that the purchasing power of their capital should be preserved, or even increased, over time?
— liarpoliticians (@liarpoliticians) August 7, 2013
I don't think it is. But to explain why, I need first to explain what inflation is.
In an economy where the money supply adjusts to economic needs*, the inflation rate is a measure of the excess of aggregate demand over aggregate supply. It is healthy for an economy to have a small excess of demand over supply, as it gives an incentive to producers to produce and consumers to consume: persistent disinflation is economically damaging, as the tendency of consumers to delay spending in the expectation that prices will fall reduces sales, depresses business income and can drive producers out of business, causing fire sales and layoffs, leading to more delayed consumption and further price falls - it is all too easy to see how this can become a deflationary spiral. But a positive inflation rate, even a small one, means that savers suffer erosion of their capital over time. The interest rate on savings is a compensation for that loss.
In an open economy, the inflation rate is not always a good indicator of domestic aggregate demand. It may indicate the extent to which demand for goods (especially commodities) in the international marketplace exceeds supply, and that affects the cost of domestic production, driving up prices to consumers especially for essential goods such as food and energy. It may also indicate fiscal tightening, as rises in indirect taxes such as VAT increase headline CPI. And it may indicate that the international purchasing power of the currency is reduced (devaluation): sterling has devalued by about 25% since 2008. The inflation rate for consumers can therefore be higher than the actual productive capability of the economy. This is what is happening in the UK at the moment. Inflation is running above target, at about 2.9%, mainly due to price rises in imported goods (notably fuel), which are partly due to the low pound (larger image here):
But the economy is growing at much less than this. Estimates vary as to the GDP growth rate at the moment but the last figure from ONS was 0.6%, which is just above the Bank of England's base interest rate, and economic growth has been hovering around zero for the last three years (larger image here):
This is dismal. It is stagnation, not growth.
So why shouldn't savers be protected from the capital erosion caused by inflation?
There are three categories of savers:
- those who are saving for something that they expect to buy in the future
- those who are storing up funds as insurance against loss of income
- those who have more money than they need for consumption at the moment.
The second of these involves the largest number of people, though perhaps not the largest amounts of money. These are people saving for retirement and for unexpected future expenses. The savings are long-term - often 30 years or more. Now, I've noted already that it is healthy for an economy to have a small positive inflation rate. Given that for savers to have a return on their savings AT ALL requires a healthy economy, I don't see any reason for savers to expect to be compensated for the natural erosion of purchasing power that exists in a healthy economy. It's a necessary cost of saving. They just need to save a bit more to allow for it, that's all. Alternatively, if people feel strongly that they should be compensated for inflation, index-linked investment products are available for longer-term savings. They will pay a bit more for them, but their capital will be protected.
But what if inflation is higher than the amount needed to keep the economy humming along? Shouldn't savers expect to be compensated for this? Not necessarily. We would normally expect that higher inflation would cause interest rates to rise, which compensates savers for the greater loss of purchasing power. Raising interest rates increases the cost of finance for businesses and households, which causes them to defer business investment and consumer spending. In an economy that is experiencing inflationary pressures due to fast growth, this is a good thing: but for an economy that is stagnating, businesses deferring investment and consumers deferring spending is disastrous. This is why "stagflation" - the combination of high inflation and a stagnating economy - is so poisonous. Raising interest rates to choke off inflation destroys desperately-needed economic activity, delaying recovery. And stagflation accurately describes the current state of the UK economy.
The desire of savers to be compensated for loss of purchasing power is understandable but wrong. The risk-free rate of return is related to the growth rate of the economy, not the inflation rate. Savers have no right whatsoever to expect to receive a higher rate of return than the ability of the economy to generate that return. If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that. If savers want higher returns they have to put their money at risk.
At the moment savers have unreasonable expectations. They expect to have returns on their savings far above the current level of economic growth, and they also expect to have their savings protected from loss. But the only way savers can have risk-free returns above the growth rate of the economy is by others - most likely government - taking on debt. It's rent-seeking, frankly. I find it extremely odd that the same people who clamour for higher interest rates for savers are also those who shriek about the deficit and warn about the dangers of high levels of government debt. They clearly don't understand that higher interest rates for savers in the present climate means a larger government deficit because of increased cost of interest service on risk-free investments (government bonds). Or if they do understand, they don't care.
And while I'm at it, I shall criticise those who want higher interest rates on bank deposits, too. Bank funding costs have a direct bearing on the cost of finance to the wider economy. Interest rates for SMEs are already cripplingly high despite bank funding rates being low. If interest rates on deposits rise, what do you think will happen to interest rates for the small businesses that we so desperately need to encourage? Really there is a logic fail here. In calling for higher interest rates, savers are effectively demanding that there should be no recovery. And in killing off such unreasonable expectations, Carney is doing us all a favour.
What we need is for savers to take risks with their money. Now there is a bit of a problem here, I agree. The "reach for yield" in capital markets caused by low interest rates and excess liquidity is leading investors to switch into all manner of high-risk investments, such as sub-Saharan government debt. I regard this as excessively risky to the point of imprudence and it is NOT what I mean by savers "risking their money", any more than I would recommend that they blow it all at Aintree or on the casinos in Las Vegas. When I say I want savers to "risk their money", I mean productive investment in their own economy for a future return - for example, in the small businesses I mentioned above. I would like to see government, including local government, issuing bonds to savers to finance long-term infrastructure and energy projects. I would like to see expansion in local investment banks and credit unions providing finance to small businesses. And I'm very encouraged by the growth of internet providers such as Funding Circle and CrowdCube bringing together small investors and businesses who need finance, crowdsourcing both debt and equity.
Obviously there are some people who need their savings to be as close to risk-free as possible - "rainy day" savings for example. I think there is a role for government in providing genuinely risk-free savings opportunities for those who need them, and recycling the funds into the economy via a State Investment Bank. But these savings, and other protected savings such as insured bank deposit accounts, should only bear the risk-free interest rate.
I've heard it argued that interest rates on savings should actually be above inflation because savers expect to be compensated for their decision to defer consumption into the future. I'm afraid I think this is utterly bonkers.Whatever the reason for saving, it gives current benefits (in econospeak, "utility") as well as future ones. If your reason for saving is to avoid paying the interest on debt, then there is satisfaction from knowing that the interest cost is avoided - and there may also be a moral satisfaction from having "saved up" for something. If your reason for saving is to insure against future loss of income, you will derive comfort from knowing that your future is secure. And if your reason for saving is that you already have four yachts, sixteen cars and a house on every continent and you can't think of anything to buy, well frankly I don't see why you should be compensated for the fact that you have more money than you know what to do with. Do something useful with it. Invest it in a small business. Give it to someone who needs it. Spend it on desperately-needed medical supplies in a poverty-stricken country. Get some "utility" from using your money to help others. You don't need it, you can't take it with you, and you certainly don't need compensation for not spending it. Really.
And finally. I really don't hate savers, but I do think they need to be more reasonable. And I do have some sympathy for those who expected to use the income from their savings to top up their state pensions, and are feeling the pinch because that income is much reduced. However, the idea that these are "poor pensioners" is wide of the mark. The majority of pensioners live on the basic state pension and additional benefits, and they are not affected by this. The pensioners who are feeling the pinch are the better-off ones, the ones who have corporate and/or personal pensions and maybe other savings too in addition to the state pension. So I'm not impressed with the "poor pensioners" argument. The poor pensioners are those getting by on the basic state pension. This lot are poorer than they expected to be, but compared with the majority of pensioners they are not poor. And I have to ask why people who are living on unearned income from savings should have their incomes protected when people who are living on earned income - many of whom are too poor to save for retirement - do not. The people who have seen the largest falls in their real incomes in the last five years are not people living on unearned income (savings or benefits), but people who are working for their living. When will I see some concern from savers - or more accurately, their representatives - for the people whose incomes are being squeezed by unemployment, under-employment, falling wages, inflation, tax rises and benefit cuts?
Related reading:
(heavens, all of it Scripture-based!)
The golden calf - Coppola Comment
The foolish Samaritan - Coppola Comment
The parable of the rich fool - Luke 12:13-21, NIV
Added 10th August 2013:
The symbolic importance of NOT raising interest rates - Tomas Hirst (Pieria)
* In an economy where the nominal amount of money in circulation is fixed - such as a strict bullion gold standard - it is normal for prices to fall over time (disinflation) if the economy is healthy, since economic growth coupled with a fixed money supply causes the purchasing power of money to increase.
The reason why middle class savers require higher interest rates is to plan for retirement. With rates close to zero, and with unknown life expenctancy, how much does a person need to save to be reasonably certain she will not run out of money? In this environment nobody knows/ If you cannot earn anything on your savings, that means you better save everything because the only think you know for certain is that you will not be able to live off the income. You will start eroding your principal the day you retire, and at a much faster rate that previous generations.
ReplyDeleteHigher real interest rates makes it easier to plan for the future. It means people can stop saving once they reach their target, and then start spending again. With ultra low rates, the only smart thing to do is to save everything.
Alternatively you - and others - can invest productively in the economy, helping to drive up growth so you can have better returns in the future.
Delete> Robert
Deletegood point, you present an scenario that low savings rates depresses demand.
" If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that. If savers want higher returns they have to put their money at risk." So with CPI at 2.9 % and growth at 0.6 %, you need 3.5% to match economic growth (ignoring tax) - where can you get this return risk-free ?
ReplyDelete"Alternatively, if people feel strongly that they should be compensated for inflation, index-linked investment products are available for longer-term savings. They will pay a bit more for them, but their capital will be protected." These index-linked investments have more or less disappeared - can you find any examples ?
You can't get that return risk-free. You can get 0.6% (or somewhere near it) risk-free. Any more than that requires you either to fork out for index-linked securities or take some risk.
DeleteRisk-free index-linked investments do exist. Here are two:
Index-linked gilts: http://www.dmo.gov.uk/index.aspx?page=gilts/indexlinked
TIPS: http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm
Supposing I wanted to have a risk free monthly retirement income of £3000, at 0.6% interest I need a principal of ~£6 Million the day I retire. That means I better save everything I can now. Of course if interest rates were 6% I would be able to retire with a principal of ~£600,000. For a middle class saver there is a big difference between £600,000 and £6 Million! I am not going to make it to £6 Million, which means I am going to be forced to take risk at the same time I am seeing my purchasing power erode.
DeletePlease explain how an economy growing at 0.6% is going to generate the income to pay you 6% on your savings?
DeleteOf course I cannot answer that. But can you answer this: With interest rates at 0.6% how much does a middle class couple need to save to retire?
DeleteI think we're at cross purposes. If you have two economies, both growing at a (real) 1% a year, one with zero inflation, and one with 5% inflation, are you saying that the risk-free (nominal) rate of return is 1% in both cases ?
DeleteRobert,
DeleteNo, I can't answer that. It depends on your view of future growth. If you think that the economy is going to continue to stagnate and interest rates will remain on the floor, then obviously you will need to save more to give the same nominal income in retirement than if you think the economy is going to grow and interest rates increase. The economy now is not a reliable indicator of the economy in 10, 20, 30 years' time.
Anonymous,
DeleteYes. Nominal risk-free rates of return are related to the growth rate, not the inflation rate. Otherwise the economy is paying out in interest more than it is generating in growth - which is a recipe for increasing indebtedness and further debasement of currency. Indexing interest rates is a dangerous game.
So in the first case I do very nicely with my 1% nominal interest and zero inflation, in the second with 1% nominal interest and 5% inflation my capital is fairly swiftly eroded. Yet the real rate of growth of the economy is the same in both cases ?
DeleteThe real rate of growth of the economy is considerably less when inflation is 5% than when it is at 1%. Your returns should reflect that.
DeleteI'm lost. In my example, I defined the real rate of growth of the economy to be 1% in both cases. What am I missing ?
DeleteIf the real growth rate is 1% and there is 5% inflation then the nominal growth rate is 6%. If the real growth rate is 1% and there is zero inflation then the nominal growth rate is 1%. So for you to have the same rate of return on your savings you need to have 6% interest when inflation is at 5% and 1% when interest is zero.
DeleteThe trouble is that if we pay you 6% when the economy is only producing 1%, we can only do it by increasing debt. So either you suffer erosion of capital because of returns below inflation, or someone else goes deeper into debt. If the debt increase is on the government balance sheet, then you end up paying anyway - after all you are probably a taxpayer, and if you aren't you will be receiving benefits that government may no longer be willing/able to pay because of the increased cost of debt service. Compensating savers for inflation is not what it seems. One way or another, the saver always pays.
I'm afraid I don't get this.
DeletePut aside the inflation issue for a moment. Are you saying that the only way to pay interest at a rate over the growth rate is by letting debt increase? Imagine an economy with zero growth (and zero inflation), government spending (before interest) of 30 and government debt of 100. If the government paid 1% on its debt and levies taxes of 31, its debt is unchanged, isn't it? It's not that you can't pay a rate over the growth rate, it's just that it then puts a greater burden on borrowers (or tax payers).
Incidentally, I'm not questioning the general thrust of your post, most of which I agree with.
fair point. The alternative is indeed to increase tax revenues. This is a) contractionary, because it extracts money from the private sector which could be spent into the economy b) likely to increase debt in the private sector.
DeleteWeirdly, it's also circular. Most of the people receiving interest on savings are taxpayers, so they would pay more in tax so that they could receive more in interest. And most of them are also benefit recipients, so they may also find their benefits reduced so that they can receive more in interest. Not sure who benefits from this, really.
Yes - it all comes down to income distribution. Pay more interest and take more tax - the private sector is in the same net position, but there are some winners and some losers. The overall effect on spending is complicated, but overall, I'd say that higher interest meant less spending as wealthier people tend to have lower spending propensities.
DeleteFrom the Bank of England website: "The Bank sets interest rates to keep inflation low to preserve the value of your money." Well, somebody here is talking nonsense. The Bank of England is maintaining interest rates at all time lows to enable banks to rebuild their shattered balance sheets. To pretend anything else - i.e. they are doing savers anything other than a disservice, is fantasy. And to expect productive investment in an economy where savings are being actively discouraged is also nonsense. Thank goodness for central planning of our economy.
ReplyDeleteHmm. Savers are of course creditors and shareholders of banks, both directly (as depositors) and indirectly via their pension and other investments. You don't think that helping banks rebuild their balance sheets, therefore making them less likely to fail, benefits savers? How strange.
DeleteThere are more savings in the world than there have ever been. We actually have a glut of savings. But most of them are not being productively used.
Saver and creditor to (probably insolvent) bank: 0% return (negative in real terms). 100% risk. Healthy alignment of interests there. The banks can also rebuild their balance sheets by not awarding bonuses to incompetent management and by not paying dividends they can't afford to idiot shareholders.
ReplyDeleteDepositors do not bear 100% risk in a bank. They bear zero risk up to the deposit insurance limit and 100% above that. If they are stupid enough to put more than £85K in a deposit account giving zero return then frankly they deserve to lose the money. That sort of money should not be in bank deposit accounts unless it is just passing through.
DeleteI agree with you that banks should not pay bonuses or dividends while they are under-capitalised. However, does your definition of "idiot shareholders" include pension funds - which manage ordinary people's savings? Pension funds are major shareholders of banks.
If you think that the deposit insurance scheme is really capable of paying out as and when required.. As to whether pension fund managers buying bank stocks are behaving intelligently.. if they're benchmarked against stock indices, then we're talking nonsense on stilts. We would do a better service to depositors in the longer run by abandoning deposit insurance altogether in an orderly fashion. Investors should be accountable for their own actions.
DeleteI'm currently writing an extended piece on deposit insurance jointly with Euronomist Blog - it will be posted on both our blogs and at Pieria.
DeleteFSCS has never defaulted on a payout, and neither has the US's FDIC. Iceland did default on deposit insurance to foreign depositors, and the EFTA Court backed it up, setting a precedent for sovereigns to refuse to honour deposit insurance in a systemic crisis. However, I doubt if any government would default on deposit insurance to its own citizens unless it was shut out of markets and unable to borrow - which I think is highly unlikely for the UK and US. So yes, I do think that UK and US deposit insurance would pay out. I'm nowhere near as confident about Euro area countries.
Good stuff. I have always been a bit puzzled by the idea that there is a significant number of "poor"savers, who (a) depend to any significant extent on income from savings rather than pensions/earnings/benefits but (b) have no assets other than cash - no shares, IL gilts, NS linked products etc.
ReplyDeleteA quibble - "But is it reasonable for savers to expect that the purchasing power of their capital should be preserved, or even increased, over time? I don't think it is."
You argue very convincingly why that is not the case *now*. But isn't it a reasonable expectation that *most* of the time the purchasing power of savings will be just about preserved or fractionally increased? I ask that on the basis of no economic theory whatsoever, but purely on the basis that that's what has generally happened. Isn't the long term real return about 1%. Even in the 70s you didn't lose that much.
http://monevator.com/uk-historical-asset-class-returns/
http://ftalphaville.ft.com/2011/05/03/557586/cash-is-king/
The long-term real return depends on the long-term growth of the economy. Interestingly there is a report out from the ONS today that shows the average growth of household incomes over the last 50 years as 1.8% per annum, which is not far adrift from your long-term rate of return. Report is here (sorry, links are not active - you will have to copy & paste into your browser):
Deletehttp://www.ons.gov.uk/ons/rel/household-income/the-effects-of-taxes-and-benefits-on-household-income/50-years-of-the-effects-of-taxes-and-benefits-analysis/sty-taxes-and-benefits-on-household-income.html
Thanks. And I have just realised in a Homer Simpson moment that the long run average is not necessarily a good guide to what you can reasonably expect in any given period. Long time since I did sums properly.
DeleteI would go a little further I think, and say that people should not expect money to hold its value over the medium to long term. As Frances says, you can expect interest at or around the level of real GDP growth but you should also expect inflation to erode your real returns over that time.
DeleteThe response to low rates is, I think, revealing of a psychological issue that people have become accustomed to receiving high levels on interest on idle capital. This expectation of high risk free returns can in many ways be seen as one of the roots of the crisis - real returns are a benefit of successfully taking risk, not a reward for prudence as many would like to think.
The debtors have long been subsidising high real return for savers. Now they need a break to rebuild their finances.
When will the banks (using that word for deposit-taking institutions)want to attract and compete for savings again? Did they ever and if so, what has changed?
ReplyDeleteWhen the Government stops giving them cheap money to pump up the housing market and feed expensive loans to SMEs.
DeleteThe main competition for time savings actually comes from funds these days, not from other banks. Increasingly in the future I think we will see banks restricted to insured demand deposits. I suppose they might start offering much higher rates to unsecured depositors, but that will push up the cost of borrowing. Most savers are also borrowers. There is no free lunch.
So would you say the bank rate has less impact on retail depositor rates than other measures at the moment? And when is that likely to change?
DeleteThere is considerable evidence that Funding for Lending depressed rates to savers.
DeleteI frankly don't think retail deposit rates are ever going to be that good again. Interest on current accounts is gone for good and in my view we will start to see transaction charges reappearing in some form or another. Other demand deposit rates should recover as gilt yields rise (they are substitutes), but realistically the government is going to continue depressing gilt yields one way or another for the foreseeable future, so I don't really expect retail deposit rates to recover any time soon if ever. And time deposits I think will (and should) become a thing of the past. There are better places to tie up your money than banks.
Setting interest rates with a regard to employment is a very political thing to do. Objectively Employment has nothing to do with Banking and setting policies for the nations money supply. Targeting employment is using the money supply as a political tool , something conventionally assosiated with parliament. Its using the Bank of England as an arm of government , with political motives. This is pretty much like the Dual mandate of the FED and a foreign concept for the UK.
ReplyDeletePlease explain in what way unemployment is a more political measure than inflation?
Delete
DeleteBecause currency is the means of exchange and its value effects prices. If the value of the currency in its role of faciliating the exchange for goods and services fluctuates it disrupts its utility. Therefore he who issues that currency has an eye on inflation as part of their role in executing that endhevour.
The level of employment on the other hand is a socio political issue fundamentally isolated from that task.
Yes, I can see the argument. But you are ignoring the relationship between inflation and unemployment:
Deletehttp://en.wikipedia.org/wiki/Phillips_curve
We can argue about the extent to which the Phillips curve accurately represents the trade-off between inflation and unemployment, but the fact remains that NAIRU is or has been a widely accepted concept. If the price of achieving price stability is high unemployment, is that really acceptable?
You only have to look at the ECB to see what happens when a central bank only targets inflation and ignores unemployment. Eurozone unemployment is over 12%. Inflation may be low, but the distress of populations across Europe is evident.
I support the dual mandate.
Surely, the interest rate paid on savings is primarily to compensate people (with money to invest) for giving up the opportunity to spend that money right now and instead lend/invest that money for a longer period of time in a potentially risky venture. The saver/investor needs to be compensated 1)for giving up their current purchasing power in order to allow a longer term investment to take place and 2) for being prepared to risk their savings in a venture/investment that may or may not work out satisfactorily.
ReplyDeleteSally,
DeleteI don't accept the "reward for deferred consumption" theory. I discussed that in the post.
However, I do agree with you that returns on longer-term investments reflect the risk of the investment. Part of my gripe with savers is that too many people expect positive returns for zero risk - i.e. if they lose their investment they expect the government to rescue them and cry "Foul!" if they don't. That I object to. High returns require that people accept the risk that they lose their shirts.
Sally, are savers and investors comparable and do they accept/expect the same risks or returns? I have some cash in NS certificates - I don't fear any (nominal) loss, nor expect much, if any, return. I have some equity unit trusts, which I hope will increase in real and nominal terms, but which I fear may tank.
DeleteAnd if savers *are* in fact leaving money in banks while getting paltry returns, doesn't that suggest there is no need for them to be rewarded? If they needed a bigger reward to persuade them to leave the money there, they'd take the money out and spend it (or invest it).
Frances,
ReplyDeleteWarren Mosler has argued that the risk free rate should be permanently set at zero. He (and Milton Friedman) argued that governments should not borrow anything. I agree.
That amounts to saying the only liability governments should issue is cash (monetary base to be exact). So the only form of GENUINELY 100% risk free saving in that scenario would be monetary base, which normally pays no interest.
On a different point, you say “Savers have no right whatsoever to expect to receive a higher rate of return than the ability of the economy to generate that return. If the economy is growing at 0.6%...”.
I suggest that interest rates don’t have much to do with growth. That is, I see no reason why an economy might not have a high rate of growth, say 5% a year, combined with a free market rate of interest which was relatively low (because there are plenty of willing savers, as in Japan, for example). Conversely an economy might have a low rate of growth (e.g. because there are no technological improvements to exploit) combined with a high rate of interest (caused by a lack of savers).
I don't really see why the supply of savers is necessarily a driver of interest rates. After all, in your world, if there is a shortage of savings for investment government can step in and plug the gap. It is the use of savings that drives interest rates, not their nominal amount. The return on investment is fundamentally a measure of risk versus return. Savers that are risk-averse and unwilling to allow their funds to be used for productive investment will have low returns. Savers that have a stronger appetite for risk will have better returns. That's the way it works.
DeleteI'm aware of Mosler's arguments, but they aren't really relevant here. The point I was making here is that there is no justification whatsoever for savers who will accept no risk being paid more than the risk-free rate of return. In Mosler's world the risk-free rate is zero. At the present it is very close to zero. That is what savers who don't want to accept any risk at all should receive.
Two thoughts apologies for my layness in economics.... This probably belongs on someone else's post but.... it's here.
ReplyDelete1) Increasingly more pensioners will be reliant on market pensions and grim annuities - this is not something getting any better - if those pensions are subject to current annuity rates most would be better off not bothering handing fees to city and trousering cash bar the subsidy to the City of tax relief. The current economics of print money and low rates set by central banks appears to help it seems only bubbles/speculators (you might reasonably argue that even a genuine market rate would be low now anyway - given the factors you mention). It [near ZIRP] is seen as an asset value pump (maybe unrelated but hard for us laity to believe that) that sees stocks/houses higher is rather undercut by the annuity rate say - but again adds to City yearly %tage scrape of pensions at the expense of final pensions.
2) Current policy which appears to lower the wages and life chances of the vast majority of people whilst an elite seem to get richer no matter how long lasting the depression is (BTW certainly on the former I am not saying that is reality only a perception).
Point is to me after 6 years of stagnation too many economists want to hide in their bunkers talking of Derp and other esoteric concepts, insults and claim everyone else wants to be Japan/is making same mistakes as Japan etc/ wants 20 years of this even without accepting little sign we don't get that anyway. That will not wash.
As a lay person I am split yes to just throw up rates would be horrible but how many years can people threaten Japan when we are Japan if not worse over the last 6 or 7 years. A tiny minority currently doing well everyone else seems screwed and yet a change in policy apparently is utterly irrational?
Yes I accept of course fiscal policy is ruled out by US Congress/Senate & the insane gutless popinjays of Labour/Liberal/Conservative. That it's a political mess why alternatives are ruled out. Maybe economists could just explain.
This is a fascinating article and I am convinced by the general thrust of the arguement, that interest rates canot be expected always to preserve the value of savings. However there are a few points in the article I find puzzling.
ReplyDeleteThe claim that interest rate are constrained by economic growth is new to me. I am yet to be convinced. I'm not sure why you use real growth rate and nominal interest rates. Surely to be comparable the nominal growth rate would be better. Real growth was 2.2% annualised* last quarter and inflation 2.9% suggesting nominal growth of around 5%.
Your explanation in the comments is that interest rates above growth would mean increased indebtedness leading to some kind of perdition. On the other hand it could just mean that more income is distributed to savers and less to other groups eg workers. It may not be desirable but undesirable things happen.
Secondly, I think there are two ideas of the risk-free rate. One is that the risk-free rate is the actual interest rate minus the risk premium. That should be the same for all borrowers. The second idea is that governments borrow at the risk-free rate, or more precisely, the risk premium on government debt is vanishingly small and so we use government debt as an index of the risk-free rate. This is fine until a governemnt's debt becomes risky (eg Italy). We need to be careful when we talk about a rise in government rates to distinguish between a rise in the risk-free rate and a divergence from the risk-free rate.
*from memory, I can't find the figure in the ONS release. The 0.6% figure you quote is the quarterly growth number.
Hi Galludor,
DeleteI admit, I have somewhat muddled real and nominal in this article. Someone else picked me up on that in the comments above.
I have a considerable problem with the idea that nominal interest rates and nominal GDP should relate. The whole thrust of this article is that they should NOT relate, because savers should not expect to be compensated for the effects of inflation. So no, I don't agree that I should be using nominal GDP with nominal interest rates. The NOMINAL interest rate - the amount that savers actually receive "risk-free" - should be set by REAL GDP, so there is no compensation for inflation. That means that risk-free savings will gradually erode over time if inflation remains positive, as in a healthy economy it should. I think this is reasonable: after all, we want to encourage people to risk their money for a return, not bury it in the ground. I really don't think we should be compensating people for unproductive hoarding. By all means let them hoard, but don't pay them to do so.
The example I gave above was real GDP 1%, inflation 5% giving nominal GDP at 6%. I really don't think there is any justification for giving savers an extra 5% just because inflation is high. Raising interest rates to choke off inflationary pressure in a fast-growing economy has this effect of course, but if the economy is stagnating and inflation is due external supply-side shocks such as oil price rises, raising interest rates can be extremely damaging. The ECB did exactly that in 2011 - raised interest rates to choke off inflation due to rising world oil and other commodity prices at the time. The result was the Eurozone crisis.
It's not "any government" that can borrow at the risk-free rate. The interest rate on US Treasury Bills is usually used as the closest approximation to the risk-free rate. The governments of the UK, Germany and Japan can also borrow at close to the risk-free rate, though there is a risk premium even on their debt. Others can be much higher. I agree that rising interest rates on government debt can indeed be due to an increase in the risk premium, not a rise in the risk-free rate due to improving economic fundamentals.
The bottom line, I think, is that unless growth returns to at least 1.5% pa, the whole edifice of our system is likely to collapse. Not because it has to - zero growth and zero rates of interest are an equilibrium, But because we are not culturally attuned to sharing out anything less than a growing pie. All current politicians implicitly rely on this. All savers and retirees depend on this. And the current level of debt already built up would inevitably default if returns cannot be generated to pay it back.
ReplyDeleteThe difficulty I have with the argument in your piece - which I find theoretically perfectly sound - is that there is no mechanism to accustom us to the likely very much lower rates of growth to be expected in the next decades. All of the emphasis of the BoE and government is to desperately steer us back to an old world which has gone, at least temporarily and perhaps permanently. Savers will not regard it as their job to invest for growth because they have never had to, they are psychologically unsuited to the task and nobody in any case is making a coherent argument (FC excepted of course!) for them to do so. Any spokesperson who explicitly made this argument would come up against a barrage of criticism. It is the commercial banks job to distribute savers money to worthy investment causes. But they have spent too long making easier money elsewhere and are now also completely unsuited for the task. It is clear that government have given up on promoting 'balanced' growth through exports and higher business investment and are now going for any kind of growth at all. In short, a housing boom plus consumer spending in some forlorn expectation that this will have any positive lasting consequences.
So what would a right thinking saver do in such circumstances? I believe he/she would take the view that least loss under the circumstances was prudent; most likely sell sterling and invest in hard assets overseas or in economies less indebted with better growth prospects.
The idea that savers should expect more than the real growth rate of the economy is bunkum. The idea that they will or should step into the breach to fill a commercial and moral vacuum created by banks and government is silly.
Frances...you are a silly Keynesian status quo supporting hag. Stop trying to force savers into the risky and manipulated stock market!
ReplyDeleteHehe. I shall take this in the spirit in which it was clearly intended. As a compliment.
DeleteAt present, the government is running huge deficits and the biggest beneficiary by far is the corporate sector. Aggregate profit margins are around 50% above their long term norm! Still, this sector seems extremely reluctant to invest in new plant or machinery, much less support new businesses. So please explain to me why household savers should be whipped into the front lines?
ReplyDeleteHaven't you got your Real and Nominal rates mixed up?
ReplyDeleteI might be mistaken but I thought per the Fisher equation the 'natural' REAL interest rate in the economy should be close to the REAL GDP growth rate?
The problem in the UK today is that with inflation at 3% and GDP growth at 0.5% the natural nominal interest rate should be 3.5% and not 0.5% as it is currently.
By the way this is not a just a post-crisis (QE etc.) problem , for 10 years prior to the crisis interest rates were on average 150bps below where they should have been.
Much as I admire your work I find this piece utterly unconvincing. The reason why savers should be paid to keep money on deposit or whatever is to stop them lumping it into property where it causes bubbles that world wide(see bubblebubble.com) ruin whole economies.
ReplyDeleteYour argument ,which ignores the constant lure of buying houses in central London as investments and not living in them and the imminence of another housing bubble in the UK (see Max Keiser) is irresponsible . People are going to try to maintain the value of their savings and the only way to do this at the moment is by investing (ultimately) in land.
(Economists have been making this point since the days when they wore wigs and wrote with quills and have been advocating Land Value Taxes of various kinds.)
We are not going to get out of the present fix while the cheap money available to stimulate the growth of goods and services gets diverted into the inelastic supply of land by those looking for a hedge against inflation.
I wonder if private neo-monopolies (rail, energy, water, government outsourced services...) with very low risk businesses would be happy with 0.5% return on capital?
ReplyDeleteI followed the link from FT Alphaville.
ReplyDeleteI am sorry, but this post is lightweight misinformation. There seems to be a basic misunderstanding in almost every paragraph, but I will raise just three fundamental ones to make the point. First, the inflation rate is not "a measure of the excess of aggregate demand over aggregate supply", at least not as these terms are conventionally defined, which is in terms of new production only. In theory, inflation is a rise in the general price level, meaning all items traded against money, although in practice of course consumer price inflation (including some assets like durable goods as well as current consumption items) is the most prominent. Even in a zero-growth economy, you might expect some inflation or deflation as the use of money across the full range of traded items changes. Second, interest is not just compensation for the inflationary erosion of principal. Interest on financial assets reflects the outcome of a freely negotiated bargain between borrowers and savers. It need not even be tightly linked to the "growth rate of the economy" (by which I assume you are referring to new production). If the central bank attempts to alter the real interest rate by adjusting the stock of money, it can expect the market to adjust the nominal interest rate to return the real interest rate back to equilibrium. Finally, despite having worked in a bank, you seem to think that bank depositors are avoiding investing in the economy, rather than sensibly employing the services of a specialist intermediary to access lending expertise and diversification. Despite the larger role of banks in the German economy, it seems to be doing better than ours.
Tim,
Delete1) Inflation is indeed a rise in the general price level. I looked behind that to the causes of that rise, deliberately ignoring the role of money itself and focusing on demand and supply. That is perhaps an over-simplification, but it isn't incorrect.
2) Interest is compensation for three things: inflation, deferred consumption and risk. I addressed all of these in the post.
3) I think you've misunderstood my point. Of course banks invest in the economy, though perhaps not enough. But depositors don't actually like them to do so if it means they might possibly lose money. Depositors in banks take no risks with their money. They are insured up to the deposit insurance limit, and historically they have expected to be bailed out for larger amounts too. They want banks to be "safe" and "look after their money". That is fundamentally in conflict with the role of banks, which is to provide capital to the economy.
I do not think that savers who will accept no risk should receive positive returns on their savings. They should receive the risk-free rate, no more - which is conventionally assumed to be the 3-month Treasury bill yield. That is very close to zero at the moment.
Germany is doing very nicely out of the Eurozone crisis. But it is actually experiencing a downturn at the moment. I've just read the IMF's Article IV review of Germany and there are some concerns, notably about its banking system (undercapitalised and fragile, especially the Landesbanken) and its export dependence.
Then you should have written something like "I need first to explain what causes inflation". In my view, if not theft, you are arguing for unlegislated taxation of the holders of nominal claims, so it behoves you to make the point rigorously.
DeleteI think you have missed my more substantive point though, which is that the real rate of interest WILL reflect the bargain between savers and borrowers. Apart from inflation and risk, the fundamental driver of the rate of interest over any particular term is the balance between preferences and the return on real investment opportunities. I dare say that on average there are enough positively returning investment opportunities that the real rate of interest tends to be positive (although any non-zero value is sufficient for the purposes of my argument). If so, attempting to adjust the money supply to hold the risk-free rate of interest down to zero will result in accelerating inflation and higher and a higher nominal interest rate as the market factors inflation into its expectations (I have just re-invented something like Wicksell's natural rate hypothesis!) - not to mention a bit more for an inflation risk premium. You end up with a distortion that it costly to unwind. I watched such a futile process unfold as an adolescent in the 1970s and 80s, and I don't want to go back there.
I am arguing that savers have no right to expect to be compensated for consequential losses from adverse economic conditions - any more than workers do. Your suggestion that not compensating savers for inflation amounts to theft or unlegislated taxation presupposes that governments have complete control over the economy. The overwhelming evidence is that they do not.
DeleteThe present situation is nothing like the 1970s and 80s. There is a dearth of positively returning investment opportunities, inflation is trending downwards not upwards and the risk-free rate of interest is zero not because of central bank action but because of the glut of unproductive savings in the economy and the preference for saving rather than spending (paying down debt is a form of saving, remember). Central banks are actually propping up the risk-free rate by paying positive interest on excess reserves.
Correct; savers have no "right" to expect compensation for inflation. It is just that, if they don't get it, and borrowers are willing to pay it, the central bank must intervene to prevent it. If this means that the central bank is breaking its promise to hold inflation within a certain range, the effect is to impose a stealth tax on the holders of nominal claims (not to mention a subsidy to nominal claims shorts). This hardly amounts to "governments" having "complete control over the economy".
DeleteRegarding the present situation, I can understand the argument that the equilibrium real interest rate is negative because of an apparent lack of promising investment projects. Based on my foregoing argument, however, the fact that UK inflation is clearly above its target would suggest that present rates of interest do not represent a stable situation - the BoE is having to introduce base money at an excessive rate to hold interest rates down.
By the way, does this mean that I am in favour of economic masochism in the UK? No. As my remark about an "apparent" lack of investment projects hints at, I suspect that there are many public sector investment projects that could yield a worthwhile rate of return, so I would advocate a fiscal response to the present downturn. But there is no way that elected politicians are going to take the political risks involved when the public can be led to look to the central bank to stimulate real economic activity.
Tim,
DeleteWhat on earth makes you think borrowers are willing/able to pay an inflation premium to savers? All the evidence is that they are not. Resolution Foundation recently estimated that a 1% rise in interest rates would result in 9% of households struggling to pay their mortgages. These are not necessarily people who over-borrowed in the run-up to the financial crisis: they are also people who borrowed prudently to buy their homes maybe 10 years or so ago, but whose real incomes have fallen in the last 3 years. And SMEs are already struggling to pay the interest rates demanded by banks. Raising interest rates would tighten SME finances even more. Hardly a recipe for economic recovery.
UK inflation, although above target, is actually within the 1% tolerance range. But we have to be very careful about interest rate policy with regard to inflation in an economy as open as the UK's. Raising interest rates to choke off imported inflation can be entirely the wrong medicine, since it puts further pressure on an already stretched supply side.
The BoE is not currently introducing base money at any excessive rate: it is not doing QE, and Funding for Lending does not introduce any new base money to the system. What it is actually doing is paying interest on excess reserves, which has the effect of holding the risk-free rate at or close to the reserve interest rate since it creates an interest-bearing safe asset which (for banks) is a perfect substitute for T-bills.
I agree with you about fiscal response. In the post I suggested that the public sector could issue bonds to private sector savers to fund long-term investment projects for infrastructure and energy development. I've been saying for ages now that when interest rates are very low and banks are damaged, monetary policy is seriously hampered and fiscal policy has to do the heavy lifting. Sadly no-one is listening.
"What on earth makes you think borrowers are willing/able to pay an inflation premium to savers?"
DeleteRight now, many borrowers would probably be unable to pay a "natural" interest rate, but I still think that monetary policy should be tightened if necessary to meet the inflation target (let's leave aside whether that is the case for now). And if that forces marginal borrowers into default and foreclosure, so be it - although I would advocate an emergency fiscal package to expedite the process and mitigate the resulting hardship.
You probably think that this is heartless, but I think it is a case of a stitch in time to save nine (or more realistically at this stage, eight to save nine). The trouble is that the lower interest rates are held and for longer, the more people come to depend on that situation continuing, and the larger the distortion necessary to keep them there continues. It has to end somewhere, and for my reasons given above, I would prefer this to end in bankruptcy than inflation. Anyway, where is the heart for those who are excluded from the housing market, either because they have been prudent or because they are credit constrained?
I used to work at the BoE, and I was warning of the danger of getting into the present situation at least as far back as 2000, but back would come the glib economist's response "in the long run, we're all dead". Continuing to supply the heroin since then has not helped the addict. Through its own weakness, the BoE has allowed itself to get into a complete monetary mess.
And, by the way, I was around when the BoE introduced interest on reserves. This was done for technical reasons, and I guess that for the same reasons, they are reluctant to give it up entirely, but I hardly think that the present rate is materially different from zero. The FLS scheme may not introduce base money directly, but it does lend government debt out of one door when the BoE is exchanging reserves for government debt at another.
> Tim Young
ReplyDeleteRather than being a bargain between savers and borrowers, banks offer an interest rate to attract deposits to use as a lower cost of settling debts to other banks rather than the cost using central bank reserves, which therefore is the price from which the interest rates are arrived at.
Sort of. The debts to other banks typically come from loan commitments drawn down. As you say, if reserves can be acquired from the central bank more cheaply than deposits, the stock of reserves will grow, but the lending will create deposits somewhere in the banking system anyway, so that the money supply overall grows and begins to bid up prices generally. For price stability, therefore, the interest rate set by the central bank must be roughly in line with the rate which balances preferences and productivity.
DeleteSurely the basis of the expectation is based incorrect idea that banking system requires deposits to make loans. As Frances has pointed out "loans ceate deposits" not the other way around. All loans could use Central Bank Reserves. The FED banned banks offering savings rates on accounts in the 1930s.
ReplyDeleteThe people who so desperately need interest rates to rise are the ones you do not even mention
DeleteMillions only get £66 a week state pension on which its impossible to live
Hence they have scrimped and scraped and sacrificed and gone without to save forsome comfort in retirement
They paid 15% interest on their mortgages and never the current 1.5%
They have no other pension or income
Hence they now face loosing their homes solely thanks to the effect of FLS
Before that hit they were coping
The last thing they want is to become a burden of the state or subject to its strictures because llife on pension credit us grim in the extreme
Far far too many people like frances and the entire mpc see savings as fun money and irrelevant ITS NOT ITS A VITAL SUPPLEMENT TO INADEQUATE STATE PENSIONand do not suggest they spend some capitol .....they cant either because they are too young or its tied up in a life trust because they were carers for sick spouses or parents
It is this section of population that frances ignores and governments could care less about and Carney most definitely has no intention of recognising
Carney is carnage and since savers simply will refuse to spend until they earn a decent interest rate and until carney et al recognise this and Cameron , Clegg and Osbourne honour their PROMISES TO HELP SAVERS the anger and hostility will continue
The government must honour its promises. But also cutbits iwn rash expenditure on quangos , overseas aid , nhs treatment for foreigners and a host. Of other extravagancies we simply cannot afford and instead pay back the debts
Robbing savers to pay debts and creating more debts is not the solution
Most of the pensioners you are talking about would not be helped by an increase in interest rates, since if someone is not getting the full State Pension (currently £110.15 per week) it is because they have not worked enough in their lifetime to have made enough National Insurance contributions to qualify - in which case it is also unlikely that they have saved much either. The pensioners that are "living on the income from savings" generally have the full State Pension which they are topping up with income from other sources.
DeleteGovernment plans to increase the State Pension by well above inflation - to £145 per week for all pensioners irrespective of contributions:
https://www.gov.uk/government/policies/making-the-state-pension-simpler-and-fairer
I think it is extremely unjust of you to suggest that I regard savings as "fun money". I do not. But I don't see any reason why a group of people who generally are better-off than the average pensioner should have their incomes protected when the ordinary working people whose taxes pay their pensions are suffering disastrous falls in their incomes. Whatever happened to "we're all in this together"?
Sorry but you are very very wrong
DeleteMy income from a life interest and my own savings as a carer ( which is why I only get £66 a week state pension ) has nose dived from 12K to 7K since Funding for Lending hit and you are clearly ignorant of such plights
You are also equally ignorant that existing pensioners will NEVER get the new state pension
I also cannot claim Pension Credit and I simply cannot live on 7K
But then as a banker you clearly have not bothered to add up basic bills faced by pensioners
Carney has signed a death warrant for Pensioners who scrimped and saved for some modicum of comfort in retirement and they have every darn right to expect rates above inflation
ONS state that inflation for Pensioners is well over 7% so CPI or 2.5% is an insult
You equally fail to recognise that 285 billion in lost savings income + lost tax to HMRC + lost VAT dwarfs the 375Billion in QE squandered on Rich asset holders ..its certainly done no good for the economy
It is the fact that the rich have benefitted while the savers have suffered that sticks in our throats and makes us mad
Strongly suggest you look at Germany where a very different attitude to savers exists along with an abhorence of debt
No amount of new debt will solve the problems this country is in nor will robbing savers and pensioners
I'm not ignorant. I'm very well aware of the effects of Funding for Lending and I know how the State Pension works. You don't qualify for the full State Pension because you haven't made enough National Insurance contributions over your working life. I don't know why this is, obviously, as I don't know your circumstances, but I'm puzzled by your statement that you can't get pension credit, as you say you have savings. However, you may perhaps qualify for other benefits. I suggest you get advice from Age UK or someone similar regarding the benefits you can claim in your particular circumstances. Pensioner poverty of the level you describe is rare these days.
DeleteYes, I know that the new scheme will not apply to existing pensioners, and I think that is wrong. Frankly that is a much bigger issue than interest on savings, since it affects far more people. If you want to shout about something, you should be shouting about that.
You say I have not "bothered to add up the basic bills faced by pensioners". Yes I have, actually. And you describe me as "a banker". I am not, and I find your use of that term in a pejorative way offensive.
Inflation is high in essential goods. I don't deny that - indeed I have written about it elsewhere. But it is equally a problem faced by low-income working families. You don't seem to care about them.
You can't directly compare QE, which is an asset purchase, with "lost savings income". And your figures ignore the fact that income from savings invested in gilts - which most annuities are - is paid from current taxation.
I totally understand your anger about the rich benefitting at everyone else's expense. But the working people of this country have suffered at least much as you. The average real hourly wage has fallen by 5.5% since 2010.
I have looked at Germany, I really don't think Germany is a good role model for the UK. Its economic strategy is seriously flawed in my view.
Finally, I would like to draw your attention to the rules of this site, which are on the "About this blog" page accessible from the tab at the top of this screen. In particular, I remind you that Anonymous posts should be signed, and that politeness towards me and others is required. You obviously feel strongly about this subject, but that doesn't really excuse your rudeness to me.
Given you refusal to understand my situation truly exists and that theres no benefit whatever available to me ....i have checked every possibility very thoroughly indeed its hardly surprising i was not amused to be told i will get the new pension when in fact even that is now going to be wholly dependant on yesrs worked so in fact in my situation i would be worse off
ReplyDeleteIt was the norm for my generation to stay home and care for children ,there were no part time jobs anyway
I also then had to care for sick spouse and elderly parent hence i do not have enough years of an income sufficent to pay NI and carers do not get credits and home responsibility protection did not exist
My generation are being treated very badly by this government just as stay at home mothers of today are insulted by Clegg plus hit by removal of child.
benefit for single earners
The same horrendous unfairness occurs when a sick spouse lands up in care
I dare not dip into my own savings because i have to cope with a likely furthur 30 years of life and cannot touch the capitol sum held in life interest
In 2008 i had a comfortable ncome of 16k ,effects of QE reduced that to 12k and now FLS has reduced it to 7k
Clearly you consider that is a fair situation sadly i simply cannot
The fact remains Cameron ,Clegg and Osbourne all promised to help savers butbinstead they have stolen every penny and Carney is complicit in that theft plus his claim on Sky news that " savers care that their children and grandchildren have jobs and their neighbours are ok " is so deeply insensitive and insulting
But then what does one expect from someone earning 875 K !!!!!
Mervyn king and the MPC never lived in the real world and neither do the bankers who caused the chaos but nothing has been done to bring them to book
So yes i am angry beyond words at the very wrong assumptions you have made in your article as to why people save
There is a 4th reason .....sheer economic nessecity
Once again you say things about me that are not true. I have not "refused to understand" that your situation exists. I said it was rare, not that it did not exist.
DeleteYou say you expect to live another 30 years.....if you don't mind my asking, could you please indicate your approximate age? I am 53, expect to live maybe another 35-40 years, won't qualify for the state pension until I am 67 and don't expect to retire until I am 70, because I think the goalposts will be moved again long before I get to 67. I still have dependent children which I have always had to work to support: I would dearly have loved to be a stay-at-home mother but that was not an option for me. And I also - now - have frail elderly parents: I haven't so far had to give up work to care for them, but I expect that will come in due course. If you are expecting to live another 30 years, you surely can't be much beyond 60? In which case, putting it bluntly, why should I be sympathetic to someone who has retired more than 10 years younger than I shall be able to do, has been the stay-at-home mum that I would like to have been and is expecting to spend a third of their life living off my taxes? I can get angry too, you know.
I'm very aware of the reasons why people save. I would like you to spare a thought for the people whose incomes are being squeezed so much that they cannot save for their futures. Economic necessity dictates that the bills are paid now, not that today's bills go unpaid in favour of future savings.
I do not support the behaviour of this government. I think it is foolish beyond words to ramp up the housing market and consumer credit in order to win the next election. But I do think Carney is doing the right thing in keeping interest rates low. I'm sorry you don't see it that way.
Please sign your post as I have requested.
In 1970 it was impossible to find any kind of job that would work around caring for children alongside a spouse working rotating shifts on 24 hour cover.so i see no reason to be criticised for having no option but to stay home
ReplyDeleteActually i am 67 and my parent died age 96 in 2007 so yes i probably do have another 30 years of life, add on caring for a very sick spouse and several years of being very ill myself life has been no bowl of cherries.
I grew up in the most abject poverty with a mother left alone in 52 when there were no benefits for widows or single mothers, she worked 3 jobs 20hours a day just to keep food and a roof .I am well aware that some families are also struggling today to pay the bills but a visit to any shopping centre sees loads of families buying armfuls of goods while pensioners are scouring supermarket shelves wondering what they can afford to eat.
The biggest problem today is it is expected that everyone has a smart phone and every child a computer and mobile phone ,even schools expect children to have computers and go on expensive school trips which adds major stresses to family budgets but generally families do not in any way live in the poverty i grew up in .
I have lots of friends on pension credit and they are finding life very very difficult indeed and they fear removal of winter fuel payment and bus pass will really put the boot in .
Council tax is supposed to be frozen but sadly not in my area .Until 2011 i too was paying income tax ,i was also helping my children and grandchildren but thats out the window now .
Theres no jobs for anyone my age and the thought of another 3years of more low interest rates fills me with dread plus we all know immigration wont be stopped so 7million unemployed will never happen
What Carney should be doing is insist the government stops overseas aid and a myriad of useless quangos and projects and pays down its debts instead
Plus bankers like Fred the shed and Applegarth should be stripped of their fortunes and repay those whose shares were confiscated
If the injustices were tackled the economic pain so many are suffering would not be so desperately unfair but absolutely no one inc Carney is worth 875 K
I'm not criticising you - though you have been very critical of me, unjustifiably so in my view. But I do get angry at your implication that all pensioners are "poor" when most are not, and that hardly anyone else is struggling when many people (especially young people and people with young children) are finding life very difficult indeed. I don't see many pensioners round the "reduced" counters in my local supermarket: I see families with children. I agree that most families probably don't live in the poverty that you grew up in - but then neither do most pensioners. Why do you want to preserve the improved living standards of pensioners when you are apparently happy to see families with young children reduced to the poverty of the slums?
DeleteAs I understand it, the winter fuel allowance is to be means-tested, not removed. So if your friends are facing losing their winter fuel allowances, it is because they are better-off than most pensioners. Please explain why relatively well-off pensioners should continue to receive this benefit?
Carney has no mandate to tell the government what to do. And I'm sorry, but when banks fail, shareholders lose their money. Their shares were not "confiscated", they simply lost their investment. If they couldn't afford to lose that money they should have sold those shares long before and invested the money in something less risky. Stocks and shares are always risky investments.
"stocks and shares are risky investments " sadly so are most other investments you propose just as many Pension Funds have become as people are finding out to their cost
ReplyDeleteSo why criticise anyone for simply saving out of taxed income to fund retirement ....their savings = their Pension
It is the failure of B of E /FSA /Treasury to monitor risky Bank practices with sub prime mortgages etc that led to the chaos and not one banker has been called to account
The young are in problems because they cannot get jobs .........why because retirement age was raised at a stroke meaning women age 60 in April 2013 got State Pension
but 60 in July 2013 wait till your 65 ........that's ridiculous
Plus huge sectors of previous big employers have shipped jobs to India
Add on the huge influx of immigration engineered by labour along with the EU and our tiny island is in big trouble and it needs politicians with real guts to deal with the issues
Sometimes though you need to look much deeper into why young families are struggling to cope and exactly what they spend money on ....and just how many children do they have
I can only guess where you live pensioners are wealthy or cost of living is lower sadly not what I observe where I live .Just as Council Tax is supposed to be frozen but not in my area .
The very major fact which belies the claims of " we are all in it together " is the Rich have done very nicely thank you from QE and no one in the world is worth 850K including Carney
Just as people need to look far closer at what problems he has triggered in Canada
FLS has caused immense problems for savers and is creating a house price explosion which is the very last thing that's needed
If your Pension Fund Annuity had been hammered you would be furious
Just as my equivalent of a Pension fund Annuity has been decimated I too am furious and rightly so
I had my fingers burnt by so called safe /less risky investments many years ago and I do not intend repeating the exercise so quite rightly when in May 2012 ISAs were 4.25% but when FLS hit they nose dived to 2.5% and continue to fall even more I and millions of other "savers" have every right to be extremely angry indeed with Carney and Osbourne along with the rest of Government policy that has failed to work in last 5 years and will not work in another 3 either
I'm not criticising anyone for saving. I am simply saying that they cannot expect the returns that they had prior to the financial crisis, because the economy simply is not generating those returns any more.
DeleteRaising of the retirement age has not much to do with the shortage of jobs for the young. The old and the young don't do the same jobs, generally. I agree that offshoring is a problem, though I'm less convinced that immigration is.
Young families are struggling to cope because their real incomes are falling due to unemployment, under-employment, wage freezes (and even pay cuts), tax rises, benefit cuts and inflation. Your implication that they over-spend and have children that they can't afford is cruel and unjust. May I remind you that it is these working people who pay your pension.
I live in North Kent, which by any reasonable definition is a poor and even depressed area. It is very evident where I live that pensioners generally are not suffering as much as families and young people. Their benefits have been protected and the state pension has risen more than inflation. Some are suffering from low interest rates, but in general the burden of poor economic performance is falling on working people and the unemployed, not pensioners.
"state pension has risen more than inflation "
ReplyDeleteYou really do have to be kidding ........even RPI is not a true inflation index and that's been replaced by CPI which includes plasma screen TVs , Champagne but NOT HOUSING
The Sept CPI figures used to uprate pensions the following April are virtually always lower than rest of the year and in any case are totally meaningless
CPI saves the government money but is totally meaningless for pensioners or low income /unemployed because their only items of expenditure have risen far far higher than CPI
Full State Pension increased by a total of £156 in April and water companies like Thames water are just about to increase everyones bills by £29 to pay for those who defaulted
Council tax in my area went up by £260 on lowest single occupier band so just where does that leave anyone on state pension ? Add on increases in food and even the much vaulted 2.5% miniumum increase on state pension leaves pensioners and low income worse off than ever
And having children is a deliberate choice which too many use to obtain council housing and benefits
Deborah,
ReplyDeleteState pension has risen by more than the inflation measures used by Government. No other State benefit has risen by so much. And no other group has had its benefits protected as pensioners have. Indeed there have been extensive cuts to in-work benefits designed to support people on low wages. And real wages have fallen by 5.5%. The increase in the State pension is being paid for out of the taxes of people on low wages whose real incomes are falling off a cliff. So I'm sorry, I'm really not very sympathetic. Others are suffering far more than pensioners.
"Having children is a deliberate choice which too many use to obtain council housing and benefits".
The sheer cruelty and injustice of your remarks beggars belief.
Clearly you have not seen the figures of just how many single mothers there are who deliberately get pregnant in order to obtain a council house and benefits that every tax payer and council tax payer is stung for
ReplyDeleteMarriage is supposed to be for the creation of children but that's been thrown out by successive governments as outdated just as Mothers staying at home to bring up there own children has or care for sick or elderly
So pleased you think Pensions have kept pace with inflation and wages because if you actually look at history its totally the opposite
Yes, I have. The number is vanishingly small. You really should not rely on what you read in the Daily Mail.
DeleteThe families that I am talking about are not "single mothers deliberately getting pregnant". They are hard-working people whose incomes are falling just when they need them most. I would like to think that you would be sympathetic towards people who are essentially in the same situation as you - i.e. suffering falling incomes through no fault of their own - but as you are cruel and unkind towards them I don't really see why anyone should be sympathetic towards you. To quote Charles Kingsley, do as you would be done by.....and be done by as you did.
The current Govt introduced the triple lock for state pensions which was a guarantee to increase the state pension every year by the higher of inflation, average earnings or a minimum of 2.5%, all the while those working suffered wage freezes.
ReplyDeletePensioners have definitely had better treatment than most other groups in recent years.
Emily
I find it quite remarkable that anyone can suggest that inflation is trending downwards. It isn't and please don't cite the utterly debased CPI as "evidence". Inflation is being actively stoked by the Government and the Bank of England (including asset price inflation) in order to monetise the otherwise unpayable debts of the Government.
ReplyDeleteONLY asset price inflation, actually. No other inflation is being stoked by the Bank of England at the moment.
DeletePrice rises in essential goods are due mainly to Government failing to control the behaviour of monopoly and oligopoly privatised utilities, plus world commodity price rises (possibly due to Fed QE).
No, not ONLY asset price inflation (as if that were somehow good). UK QE inevitably puts downward pressure on Sterling because if investors are getting a sub-inflation return on Sterling (which they are because that is the only way the UK can fund its unaffordable deficits), then the currency will take the strain. That drives up the cost of importing things people need on a day-to-day basis (like food and energy). And while the privatised utilities are far from innocent, it is the Government's renewables policy which is paid for by inflation-busting price increases passed on to people on low incomes: a regressive tax so that upper-class rent seekers like the PM's father-in-law can trouser a "modest annuity" of £1000 per day, and the Deputy PM's wife can collect consultancy fees for lobbying for a Spanish wind farm company.
DeleteThere is zero evidence that QE debases the currency. Here are the 5-year charts for sterling versus USD, EUR and JPY (sorry, links are not live - you will have to cut and paste into your browser):
DeleteGBPEUR: http://uk.finance.yahoo.com/q/bc?s=GBPEUR=X&t=5y&l=on&z=l&q=l&c=
GBPUSD: http://uk.finance.yahoo.com/q/bc?s=GBPUSD=X&t=5y&l=on&z=l&q=l&c=
GBPJPY: http://yhoo.it/1cuGKDB
In each case the devaluation of sterling caused by the base rate cut in 2008 is very evident. But there is no evidence whatsoever of the two rounds of BoE QE having any effect at all. In fact GBPEUR actually rose during the second round of BoE QE due to sterling being regarded as a safe haven during the Eurozone crisis.
There is evidence however that QE drives up the world price of commodities, which feeds through into higher food and energy prices in the UK.
I agree with you about the Government's renewables policy. It is the wrong policy implemented at completely the wrong time.
Housing prices are being deliberately stoked by the Government and B of E via FLS and HTB and also swelling the pockets of developers but very conveniently housing is EXCLUDED from CPI
ReplyDeleteSince CPI is in no way whatever representative of the average person and definitely not of low income families or pensioners it is totally and utterly meaningless
If the Gov want to be taken seriously they should stop all Foreign Aid along with Quangos and a host of failing projects and use the money to pay off the debts
Since a certain T Blair and G Brown led us into the mess and have plenty of spare millions along with Applegarth , Fred Goodwin etc they had better make them accountable too
As for Carney if he had one ounce of decency he would only accept the same outrageous salary Mervyn King got because he is not worth any more and theres plenty in Canada who were glad to see the back of him
Good heavens, something we agree on at last. I am totally in agreement about the idiocy of Government policy regarding housing. Ramping up the housing market is utterly wrong and stupid. On this almost everyone seems to be agreed except estate agents and some developers (no surprises there).
DeleteRegarding the rest - if only things were as simple as you think. But they are not.
Isn't it interesting that when the Government lends, rather than borrows (viz student loans), it's preferred inflation index is RPI, not CPI i.e. something much closer to real inflation rather than "inflation with the bad bits removed"?
DeleteIts all perfectly simple if anyone in power has the guts and the common decency to do the right thing
ReplyDeleteInstead its the savers who did the right thing and went without only to be screwed on the orders of Bilderburg( just read The Money Masters
We all know who a leading light in that lot of shysters are
MC himself
From your post: “But is it reasonable for savers to expect that the purchasing power of their capital should be preserved, or even increased, over time?” Wrong question. It is not so much that savers “expect” the purchasing power to be preserved as they expect fair rent for the use of their property. When their money is lent out to others at interest, it is not fair that the banks make all the money. Savers are not expecting profit (unless they lock up their deposits in a CD), so much as fair rent. Fair rent means their money is not losing value in the bank. Otherwise, they might as well not put it in the bank. If they lock up their deposit, the rent should be an interest rate exceeding the rate of inflation.
ReplyDeleteYour misunderstanding of savers' expectations is evident in this line, “But a positive inflation rate, even a small one, means that savers suffer erosion of their capital over time. The interest rate on savings is a compensation for that loss.” The bank has no responsibility to compensate savers for inflationary erosion. The bank does have responsibility to compensate savers for using their property to make money for itself.
“If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that.” This is just wrong. The basis for the savers' expectations is not the growth of the economy, but the piece of the action the bank is getting by lending out their property. The growth rate of the economy is immaterial. If the bank lends my money at 6%, and the rate of inflation is 2.9%, the saver should get that 2.9% part, and the bank can keep the remaining 3.2 % as its profit. If the saver has lock up their deposit, the bank should compensate the saver even more, and retain less as profit as its cost of doing business with funds not on withdrawal demand.
Er no. If those really are savers' expectations, then they do not understand the nature of their contract with banks.
DeleteWhen you put your money in a bank you are lending it to the bank for an agreed return. You have no right whatsoever to dictate what the bank does with your money, and no right to demand any share at all in any returns it makes from its use of your money over and above the agreed amount. If the agreement with the bank is such that it can vary the amount of interest it pays you at its own discretion, then it can reduce the interest it pays you to 0.01% and you would have no right whatsoever to demand a higher interest rate even if the bank was earning 20% on lending. Your only recourse is to close your account, withdraw your funds and try to find somewhere else to put them that will pay you a higher interest rate.
That, I'm afraid, is the nature of the deal with banks. Your comment is therefore wrong from beginning to end.
Oh, and you have no guaranteed right to return of your money, either. Once you have lent the money to the bank it is not "your property" that you have entrusted to them for safe keeping. It is a loan, and your money is at risk. If the bank fails, your right is to a share of the bank's assets, which may or may not be sufficient to compensate you for your loss.
In the UK we have deposit insurance which will compensate you for losses due to bank failure on amounts up to £85,000 in one banking group across all accounts. Above that, you may lose your money - as depositors did in the failure of Southsea Bank in 2011.
"Once you have lent the money to the bank it is not "your property" that you have entrusted to them for safe keeping." Interesting that does not apply the other way around when the banks lend "their property" to me.Save and safe are basically the same word.If the banks' "agreement" with depositors is really as you describe, it seems the account opening documents should be required to say so.
DeleteGood post. I have to admit I found much of it uncomfortable reading, but on reflection I'm pretty sure I deserved to.
ReplyDeleteI do think there's a significant minority for whom your first category of saving - "for something that they expect to buy in the future" - is NOT short-term: housing for people living in or near London. Given the magnitude of the current bubble there, anyone not sucked into the HtB madness can only really save against either some future return to sanity or the day when they move away, possibly upon retirement. Potentially decades away, in either case.
The end result of the Government engineered robbery of savers by FLS will without doubt come back to bite them
ReplyDeleteIts very very clear that all current MPs have been told to fob off every constituent who complains
Carnage is a puppet of Osbourne and theres only one thing on their minds = robbery
A huge housing bubble is already underway and Canada is tanking thanks to Carneys work
What he did there is being repeated here total and deliberate theft from savers to reward feckless debtors and inflate away public debt when actually the Government should be putting its own house in order
Just one illustration this AM they got rid of 800 Civil servants and hired 1200 Consultants in their place at huge extra expense
Who is paying for it ?????????????? Savers
Not content with that DWP is providing false information to IFS so their reports on Financial inequalities are totally incorrect
Frances, thank you for this interesting essay. However, I dare to not agree ;-)
ReplyDeleteI see money as a bearer of prices and prices are *signals*, signals that steer investments, savings, consumption, by the invisible hand.
The money system in my opinion must be optimized for getting these signals (prices and price changes) as clear and uncluttered through the system (economy). And the monetary system should be optimized only for that. So stable prices if nothing (demand, production, amount of people and so on) changes. If producers and traders need not worry about inflation in their decisions on investments, we have this optimal monetary environment for the productive class.
No what I feel is that some see undesirable effects in society as a consequence of such hard money system. Some groups, debtors or minorities or whoever are not getting their 'fair' share.
My point is that if that is the case (and in a democracy the majority is right, by definition), than the chosen wealth redistribution objectives must be arranged by taxes and only by taxes, but not with tampering with the money system itself (under the assumption it is optimized as per above). If you try to optimize the monetary system for other goals than clear price signaling, prices signals get distorted, leading to misallocations and malinvestments. Society as a whole becomes less efficient (net costs of booms and busts) and that has a negative impact, especially on the middle class and poor.
(By the way, I don't believe the "a little inflation is good for employment" argument. It seems a case of 'correlation does not imply causation'. And even if people believe this stimulus is needed, it surely can be emulated by taxes and subsidies with the same net effect, right? With the added advantage that the price signal function of the money circuit does not get tainted).
To summarize: use a monetary system that is as efficient as possible for trade and industry and use taxes and subsidies for reaching social goals, but please do not mix.
Henk, Netherlands.
well said Henk
ReplyDeleteTragedy is under current crazy monetary policy the Rich are getting richer by the minute thanks to increase in asset prices and paying less and less tax while the Pensioners who rely heavily on savings interest are being systematically robbed
Frances
ReplyDeleteHow do you reconcile your contempt for government housing policy with a belief in low interest rates (1.69% mortgages).
Low rates = housing market ramp up.
You like low rates = you are a supporter of the ramp up.
You are a cheerleader of bubbles.
We have had interest rates at unprecedentedly low levels for the last five years. Where is the housing bubble? And don't cite London - the recent house price rises in London are largely due to two things: 1) cash purchases by overseas high net worth investors fleeing Eurozone trouble spots (no mortgages involved) 2) growth in buy-to-let, mainly due to tight credit conditions for first time buyers increasing demand for rental properties. Neither of these have anything to do with low interest rates. The fact is that the low interest rates of the last 5 years have not caused a housing bubble.
DeleteThe residential housing bubble that grew BEFORE 2007 has not fully deflated and further correction is needed. Government policy - not only Help To Buy and FLS, but above all failure to address unnecessarily restrictive planning laws - is preventing that from happening. It is the restriction of supply, not low interest rates, that above all maintains high housing prices.
Current economic conditions require low interest rates. Savers' demand for higher interest rates simply because they are used to higher interest rates is rent-seeking, pure and simple.
Frances
ReplyDeleteHow about the other side of the equation - do you believe that debtors "deserve" to be able pay negative real rates of interest?
If savers demands under a system of government price fixing are "rent seeking", are not debtors demands nothing but welfare receipts and out and out scrounging?
You seem to suggest our society can be built on LBO kings, corporates and BtL landlords who are releveraging should be in receipt of huge welfare receipts...
Your comments (and particularly that above) are grossly naïve and ignorant of the facts - For example, BtL is driven almost entirely by interest rates. Low Interest rates are stopping the housing bubble deflating appropriately. It is als the case that LOW INTEREST RATES CREATED THE PROBLEM IN THE FIRST PLACE. FLS has reduced mortgage rates and driven house prices in London Boroughs in the last 6-9 months - LOW INTEREST RATES DRIVE THIS.
This is the problem when government interferes with such a key price - savers end up having demands. However, if the price of money was determined freely by market participants, there would be no demands, it would be what it would be. It is called the price signal and it helps people appropriately allocate their resources.
If this country wishes to grow, it must invest. If it wishes to invest, it must have a stock of savings. To have a stock of savings, it must offer a return. A perpetual negative real rate of return does not increase your stock of savings BUT it will lead to greater leverage and debt and THAT is exactly what is happening.
You focus the article of demands of savers but uoi ignore the detrimental effect it has on the economy more broadly and indeed to society.
Given that economists and certainly the Fed and BoE have covered themselves in failure, what makes you think they are well placed to determine this most important price?
Ignorance of human behaviour and simply no lessons learnt. Your views are sgared by most policy-makers- it is truly frightening.
Your belief in low interest rates will merely result in the
Contrary to your belief, low interest rates are not about "giving in to debtors' demands". They are intended to encourage spending, which generates economic activity, and business investment. Businesses facing high finance costs don't invest: businesses facing poor demand don't invest. The last five years has seen a massive failure of business investment. It is now beginning to pick up, but demands by savers for interest rate raises are premature. Raise rates now, and the life will be crushed out of the very fragile recovery we are beginning to see. Your exclusive focus on housing misses this very important point.
DeleteFrances,
ReplyDeleteI am a successful businessman so please don't patronise me. And I can assure you that artificial interest rates do no-one any good bar speculators, given others seem to have to pick up the tab.
Business investment was low in the lead up to the crisis and has been low ever since despite the lowest rates in history. In my sector, this is because costs of investment have increased (through low rates and QE) and the margin available is diminished (too much capacity as too many players eke out returns below their cost of capital but are kept alive by free money.
You have a frighteningly simplistic moral view of the world without understanding the consequences.
Tell me what kind of activity it is you think free money is producing - maybe you want to ask US bank mortgage originators who are now losing their jobs after the refinance boom on artificially low rates.
This is a more recent example of what happened in the Dotcom crash and in the housing/credit crash - free money is artificial investment and when it disappears, so does the activity. All this does is destroy lives and families - I have been here as well!
I am not "patronising" you. I merely pointed out something that in your previous comments you had completely failed to mention.
DeleteHowever, I would appreciate it if you would please refrain from patronising me, and from attributing to me moral beliefs that you do not know I hold. If you wish to criticise the substance of my argument, please do so from a rational standpoint with appropriate use of facts - as I have done. Phrases like "you have a frighteningly simplistic moral view of the world without understanding the consequences" do not constitute rational critique of my argument.
You don't say what your "sector" is, but the sector that is most adversely affected from an investment point of view by low interest rates is the financial sector. If it is the financial sector that you work in, you have my pity, but not my sympathy. The financial sector likes to think it is the driver of real activity in the economy, but it is not. Real businesses benefit from lower finance costs. It is unfortunate that the benefits of low policy rates have not reached smaller businesses because of a very damaged banking sector, and in my view further measures are needed to ease financing conditions for smaller businesses: but the damaged credit transmission mechanism is emphatically not a reason to raise rates. And neither are the screams of savers suffering from very low interest rates because the world has more capital than it is able to use productively at the moment. We need to improve investment before we can raise rates. Otherwise you are putting the cart before the horse, and both will end up in the ditch.
Frances,
ReplyDeleteIf there are excess savings, rates will reflect this without need additional central bank & government intervention.
"Productive" investment does not require free money - this helps speculators. Activity requiring negative rates is NOT productive.
I have never come across a business that makes an investment decision for productive activity that depends on a couple of points in cost of capital. BUT I have come across plenty of speculators (corporate, financial, property and individual) who play on this vis a vis asset prices. This is one reason why mortgage lending occurs (for BtL) with the FLS scheme but not SME lending - it is less price sensitive.
So we end up in a speculative, financialised, distorted economy where all our capital goes into 1.69% mortgages on unproductive assets all because people like you believe that savers should earn a negative return to help out.
It does not help out, it distorts incentives and will lead to greater aggregate indebtedness as demonstrated both pre and post crisis.
Helping out should be a fiscal response. Playing with money is nothing but an activity of scoundrels.
I do not operate in the financial sector and would never dream of doing so as I do not regard myself as a sociopathic scrounger. I am not convinced you can argue that the financial sector has suffered at the hands of low rates, or is it the level of compensation you regard as inadequate?
There are indeed excess savings, and worldwide interest rates reflect this. Interest rates have been trending steadily downwards for the last thirty years. Believe it or not, the present yields on USTs, which as I'm sure you know are the closest approximation to the risk-free rate of interest, are "on trend" - they were slightly below trend in 2012 but have now bounced up. Gilts have done exactly the same, not surprisingly because gilt yields are largely set internationally. The current base rate is consistent with short gilt rates, just as the short end of the UST curve is consistent with the Fed Funds rate, and all of them are "on trend". Unless you can think of a good reason why the long-term interest rate trend should now reverse, current interest rates accurately reflect the global demand for capital and there is zero reason to raise them.
DeleteProductive investment requires there to be 1) potentially profitable investment projects 2) finance available at rates that will enable positive returns on those projects. The supply of 1) is restricted, partly because of low economic demand in Western economies and partly due to other factors such as the growth of less capital-intensive service industries, and 2) is simply not happening for smaller companies due to a very damaged banking sector, as I explained. Your assertion that the cost of capital does not matter for productive investment may be your experience, but I have to say it is not mine. At the margin, a few basis points on the cost of capital can make the difference between a profitable and unprofitable investment.
The reason why banks are not lending to SMEs is because SME lending, being riskier, requires more capital. FLS includes a capital concession, allowing banks to use Tier 2 capital buffers to support additional lending, but for banks that are still building up their capital levels - or, like the Co-Op, have serious capital shortages - even this is too much. The fact that FLS has mainly gone into mortgage lending is entirely because of damaged bank balance sheets. Banks are under regulatory pressure to reduce their balance sheet risks, and property lending, even for BtL, is simply less risky.
I am no supporter of Government policy regarding the housing market, nor indeed of QE - as you would know if you had read my other work. But the current low base rate is supporting the economy as a whole, not specifically the housing market. And as I've pointed out elsewhere - and contrary to popular opinion - international funding rates were already falling by the time FLS was introduced and it is questionable how much effect on deposit rates it has really had. Fundamentally, savers are earning a negative return because demand for capital is low. If some savers are struggling because of that, the appropriate response is fiscal, not monetary.
Low mortgage rates are disastrous for lenders. Banks cannot reduce their funding rates below zero, so mortgage rates at 2% or less is a serious margin squeeze. Mortgage rates have actually been rising since 2012 because lenders can't cope with the hit to net interest income: some lenders have cut their rates as a consequence of FLS, but a lot haven't and some have even raised them (most recently West Bromwich BS, which last week raised rates by 2% on its portfolio of mainly buy-to-let prime residential SVR mortgages). Low rates are also disastrous for pension funds. So yes, I can argue that the financial sector has suffered because of low rates, and it has nothing to do with compensation levels.
I think you should refrain from using phrases like "sociopathic scrounger" about people who work in the financial sector. The financial sector performs a useful function, and most people who work in it are ordinary people doing ordinary jobs for ordinary wages.
Frances,
ReplyDeleteSo in essence you feel that government intervention has had no effect on the price of money and the cost of capital? Has QE had no effect? If so much capital around, why print so much more?
"At the margin, a few basis points on the cost of capital can make the difference between a profitable and unprofitable investment". If this is the case, why do you wish for low rates to lull people into a false sense of the cost of capital? This is why we had a crash in the first place and why capital gets misallocated to speculative uses.
I could perhaps be more specific but I imagined you would have grasped that my description of sociopathic scroungers relates to the leadership of an industry that would ordinarily be dead on the floor following their actions (and that of central bankers) but have rather sought to boost their compensation, rather than the capital of their banks, despite their institutions still being insolvent. At the same time, they lobby against change and deny the full range of support from the hard working, struggling families you suggest that you support.
I think UK central bank intervention has very little effect on the price of money and the cost of capital. US central bank intervention has far more. But the Fed Funds rate is set by the market, not by the Fed, and the Fed has had to work hard to keep short-term rates above zero - that's why it is paying interest on excess reserves. The simple fact is that the natural rate of interest on capital at the moment is very low because there is little demand for it.
DeleteI have written extensively about QE and its effects, and I am not going to repeat that work here. I refer you to my posts on the subject. However, I must point out that QE does not create capital - it merely exchanges one form of capital for another. QE increases base money (bank reserves) but removes an equivalent amount of other safe assets from circulation.
I'm not going to discuss further the question of low rates. Rates are low because there is little demand for capital. That as far as I am concerned is the situation.
"At the same time they lobby against change and deny the full range of support from the hard working struggling families you suggest that you support". I do not work for the financial industry, and I have been extremely critical of the behaviour of senior management in many banks and financial institutions. Once again, you don't seem to have read my other work. Can I suggest you do so before you make any more wild accusations about my motives and my beliefs?
Utterly bizarre!
ReplyDeleteI assume you agree with the Bank of England increasing bank rate and selling its gilts accumulated under QE then?
ReplyDeleteI see absolutely no reason for it to do so.
DeleteBut you seem to think the BoE has no influence on the price of money and the cost of capital, so why not?
ReplyDeleteI said little influence, not no influence. But as current rates are consistent with economic need and international market rates, I see no justification whatsoever for raising rates or selling gilts.
DeleteFrances
ReplyDelete"we've intentionally blown the biggest government bond bubble in history".....Andy Haldane, Financial Stability and the Bank of England.
Last time I looked, government bonds affect other credit prices and the cost of capital.
Delighted you share in the delights of vast government bond and credit bubbles which will be exacerbated in coming years through ever cheaper money because of your "economic need"......
You simply fail to understand that making money free encourages excess indebtedness...in ever greater cycles of asset price inflation and credit accumulation...NOTHING IS SOLVED!!!
Utterly bizarre and disorientated thinking on a grand scale.
I don't "fail to understand" anything.
Delete"Utterly bizarre and disoriented thinking on a grand scale".....simply because I don't agree with you. You have no idea how to conduct a civilised rational debate, have you? I'm not accepting any more rudeness from you. You haven't even had the courtesy to identify yourself.
I will not post any more comments from you.
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