sábado, 11 de diciembre de 2010

sábado, diciembre 11, 2010
Why we have to live with low interest rates

By Martin Wolf

Published: December 9 2010 21:54

The Bank of England’s monetary policy committee confirmed its 0.5 per cent base rate of interest on Thursday. Thus the UK remains, with the Federal Reserve of the US, the Bank of Japan and even the European Central Bank in the very low interest rate club. Critics argue that this policy – even more than quantitative easing, in which the Federal Reserve is now engaged and the Bank of England may engage again – is unfair and inefficient. Are they right? “Yes and no” is the answer. These are bad policies. But alternatives are worse.


Ros Altmann, a well-known British expert on pensions, has sounded the charge in the UK. She has argued that the policy amounts to an unfair tax on savers in general, and the old in particular, undermines pension plans and distorts the market for long-term government bonds. To this, Andrew Smithers of London-based Smithers & Co adds, in a critique of quantitative easing published in October, that the policy can work only by creating new and perhaps even more damaging asset bubbles in future.


Consider these points, in turn.


Yes, lower interest rates transfer incomes from lenders to borrowers: at the end of the second quarter of this year, UK households held financial claimsother than equities, insurance policies, pension fund reserves and “other accounts receivable” – worth £1,257bn, or 86 per cent of gross domestic product, while they owed £1,539bn. Thus, a 1 per cent fall in interest rates shifts close to 1 per cent of GDP from lenders to borrowers.


Is this “unfair”? It is not evident why. In general, lenders would be older, as Ms Altmann notes, and borrowers younger. As Charlie Bean, deputy governor of the Bank of England, has controversially noted, older savers have benefited from huge capital gains on their houses. Indeed, the credit expansion that has left many younger house buyers so heavily indebted fuelled those gains. Nor are savers the only losers in this recession.


Furthermore, as Mr Bean noted, it is normal for older people to live on capital, as well as income. True, annuity rates are low. But this is a good reason not to force annuitisation.


A common complaint is that low interest rates reduce saving. In fact, their impact is ambiguous: they create an “income effect” – by making savers poorer, so encouraging higher saving – and a “substitution effect” – by lowering the cost of spending now, relative to future spending, so promoting consumption. Yet, if desired savings were lowered, that would be no bad thing now. The government’s fiscal tightening actually depends on an offsetting surge in private spending.


Ms Altmann is correct in arguing that a low interest environment undermines defined benefit pension plans. But the biggest difficulty here is that past pension promises were based on unrealistic assessments of long-term real rates of return. As the McKinsey Global Institute argues in a new report, we are coming out of an era of falling costs of capital.* This was generated by real forces – principally a decline in desired investment. Current low short-term interest rates are almost a bagatelle in comparison.


The deepest question is whether current policy risks generating huge disturbances in future. As both Ms Altmann and Mr Smithers note, encouraging spending by raising asset prices evidently risks creating another round of what Austrian economists labelmalinvestment”. Credit may also surge, once more, generating another round of irresponsible behaviour in the financial sector and ultimately another wave of financial and economic crises, quite possibly in emerging economies. It would be foolish to ignore those evident risks.


Yet it would be just as foolish to ignore the just as pressing present dangers. Today, the UK and a number of other economies, including the US, are both excessively leveraged and have weak financial sectors. The low interest rate policy is designed to prevent an uncontrolled collapse of this mountain of leverage into mass bankruptcy and, instead, allow debt to be paid down and the financial system to return to health more gradually.


Thus, we have to choose between low interest rates on current assets or better returns on what would soon be shrunken assets: with higher rates, house prices would fall further, unemployment would rise, more loans would default and banks would fall back into difficulties. Ms Altmann argues that the bubble economy was partly an illusion. So, then, must be a big part of the financial claims on which savers now depend.


As the punch line of the old Irish joke goes, “I would not start from here”. Yet we do. We have to make the best we can of the inheritance. The task is to cure the ills bequeathed by the last bubble, without creating either a depression or new bubbles. Are we doing a good job? No. But it could be worse. Would tightening fiscal and monetary policy, at the same time, be the remedy? No. That way lies a slump. Some savers might indeed benefit. But losers always outweigh gainers in such a collapse.


* Farewell to cheap capital? www.mckinsey.com/mgi/publications


Copyright The Financial Times Limited 2010.

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