November 15th, 2013
As we approach the fifth anniversary of the start of quantitative easing measures by central banks, McKinsey has produced a helpful report on the winners and losers of QE. The report looks at the impact of asset purchases on the borrowing costs and income of governments, corporations, insurance companies and households.
The headline finding is that governments have been the biggest beneficiaries as a result of lower borrowing costs and remittances from central banks that hold their bonds. Non-financial corporations also did well out of QE, as did US banks that could pay rock-bottom deposit rates and boost interest margins. The big losers were households whose cheaper borrowing costs were outweighed by reduced savings income and annuity rates on defined contribution pensions.
While the near-meltdown of the system that prompted QE in 2008 has receded from peoples’ memories, the debate has shifted to whether the continued measures – which feel semi-permanent – are benefiting the most vulnerable corners of the economy or are merely increasing inequality by making the rich richer.
Some commentators have pointed to McKinsey’s headline findings as evidence that QE doesn’t only benefit the rich. They do that by conflating ‘governments’ with ‘taxpayers’. This may be naïve, because it ignores a huge principal-agent problem. To understand this, consider the hidden beneficiaries of QE not discussed by McKinsey.
As McKinsey explains, households got hammered because interest on savings or annuities plummeted as a result of QE. That happened because they live in a mark-to-market environment. Those with corporate defined benefit pensions – promised a lifetime income regardless of the price of government bonds or annuities – have done better, except for the fact that companies sponsoring such plans are shutting them down.
That leaves the biggest recipients of DB pensions, whose employers are insulated from market volatility. Yes, government employees. The UK spends about £20 billion a year on central government pensions according to the National Audit Office. That’s roughly the same as the annual benefit that the UK government has enjoyed from QE since 2007, according to McKinsey’s data.
In the US, Federal employee pensions and healthcare benefits cost about $85 billion per year according to the Congressional Research Service. That’s 40 percent of the US annual QE benefit identified by McKinsey. In a sense, the ‘taxpayer benefit’ of QE amounts to raiding the savings of non-DB households and paying it straight to these government retirees. (See Note 1)
These figures don’t include the benefits of local government employees but arguably the same wealth transfer is taking place there too. Although policymakers in the UK and US have attempted to cut public sector payrolls and trim DB pensions, the results have been limited so far. Without QE, higher government borrowing costs would dramatically increase the pressure for reform.
Then look at the impact of QE on asset prices. The McKinsey report says it is hard to quantify the impact on equities and real estate, but the boost in the value of government bonds is obvious. Did that compensate those households who lost out from QE?
The answer is only very selectively. The FT’s Gillian Tett highlights a study by graduate student Sandy Hager who finds that the richest 1 percent of Americans own 42 percent of privately-held US Treasury bonds. Although Tett doesn’t make the connection with QE, this figure seems to support the argument that QE has enriched a minority.
What these numbers suggest is that there are two constituencies that have benefited most strongly from QE – government employees and very rich people. These vocal constituencies may have the most to lose from QE ending. Perhaps that explains why central bankers are in no hurry to upset the apple cart they created.
Note 1) It might be argued that only the unfunded part of these pension payments are true wealth transfers because the rest is funded by employee contributions.
Note 2) The McKinsey report considers the economic benefits of additional consumption resulting from the wealth effect as QE boosts asset values. In other words, the windfall spent by government retirees and rich holders of bonds and real estate trickles down to the unluckier households.