The Bank of England – more accurately, someone from it, Gertjan Vlieghe – has good news for public sector employees. Their compensation for turning up to work has just gone up. Equally, bad news for private sector workers for the pressure is going to be the other way. This might not be what is first thought of when discussing the yield curve post the unwinding of quantitative easing but it is all indeed so.
The point he’s making in his recent speech is that as long as no one does anything silly then unwinding all of that unconventional monetary policy isn’t going to be a problem. It’s the next bit that’s problematic. For that yield curve – where long term interest rates are substantially higher than short term – has changed. Now that we’ve got a central bank that knows what it’s doing that’s not going to be true off into the future. We’ll be back with how it was under the gold standard, rates didn’t vary that much over maturity.
A corollary of this is that if we’ve a central bank that knows what it’s doing then real interest rates aren’t going to return to the levels of the past either and that’s rather what kills certain types of pensions. That traditional defined benefit pension, in the private sector that is, suffers badly from a future world of low ongoing interest rates. We can see this from what has happened at BHS and other places. In 2006 that pension fund was around and about fully funded. In 2009 it wasn’t and then it got worse again in 2015 or so.
The problem, and this is common to all such funds, is that low interest rates increase the value of bonds held, they surely do. But they also increase the costs of guaranteeing an income at a certain level for decades. And the decades of the guarantee are longer than the life of the bonds being held. Significantly low long term interest rates thus pretty much bankrupt pension plans as traditionally constituted. So, in comes QE and the BHS pension fund falls into deficit. When it becomes clear that QE isn’t going away quickly, it falls further. This is not confined to the one company – any survey of British industry will reveal the most horrendous, alarming, pensions deficits on an actuarial basis.
What’s been keeping the show on the road, to an extent at least, is the assumption that once QE goes, as it will, then interest rates will return to their old pattern and the funds will come back into balance and or surplus. Those funding costs of the long lived pensions will fall further than the decrease in asset values, the reverse of the earlier process.
That’s the implication of what Vlieghe is saying, that this isn’t going to happen. Because the yield curve isn’t going to snap back and also rates aren’t going to rise that much with the implication as the Telegraph says, “schemes face bigger deficits for the foreseeable future.”
This is, of course, bad news for all private pensions. Anyone saving on their own – defined contribution pensions included – is going to gain lower investment returns from their savings. They’ve either got to put more in for a given pension from current resources or put up with a lower retirement income. Note that pensions are simply deferred wages and this means, in effect, lower wages for all in the private sector.
The effect in the public sector is entirely the other way around. There many to most are still on defined benefit pensions. And it’s us as taxpayers who pick up any shortfall in what is currently being put aside to invest for those pensions and what is needed to actually pay them. So, the amount of pension to be received by our toiler in the bureaucracy doesn’t change with these interest rate changes. Nor do the contributions they pay.
But, obviously enough, the value to said toiler increases as returns on monies invested fall with us picking up the tab. For they’re gaining that same defined pension all along while not having to save more for it. That council or government pension increases in value even as we’ve all got to pay more for ours – because we’ve got to in fact.
We could just say that it’s great there’s a silver lining in this but given who has to pay that bill that’s probably not the right solution. Instead perhaps we should be properly calculating those pensions values when we compare public and private sector pay, not something we do well at all right now.
If real interest rates are going to remain low post-QE then the current woes of British industry attempting to afford the pensions already promised will continue. And the gap between public and private sector pay will continue to widen in favour of that public sector as we have to pay for their pensions.
If we really want to look for a bright side to this we could think of the imminent Corbyn government whose inflation uncertainty will get those real yields back up nice and sharpish but wouldn’t it be easier just to measure the values of pensions properly in the first place?