Tuesday, August 9, 2016

Yves Smith — Economists Mystified that Negative Interest Rates Aren’t Leading Consumers to Run Out and Spend

"Earth to economists."
Naked Capitalism
Economists Mystified that Negative Interest Rates Aren’t Leading Consumers to Run Out and Spend
Yves Smith


Matt Franko said...

Pretty good from Yves here:

"People save for emergencies and retirement. Economists, who are great proponents of using central bank interest rate manipulation to create a wealth effect, fail to understand that super low rates diminish the wealth of ordinary savers. Few will react the way speculators do and go into risky assets to chase yield. They will stay put, lower their spending to try to compensate for their reduced interest income. Those who are still working will also try to increase their savings balances, since they know their assets will generate very little in the way of income in a zero/negative interest rate environment."

Same for institutions with defined benefit plan obligations....

Seve141 said...

ZIRP or any other central bank interest rate policy is just one of several variables that impact defined benefit pension obligations.

The legal obligations of the plan are straight forward (aka defined), so there is no quibbling about the liability.

Actuarial firms are contracted to make an appraisal which requires making economic and demographic assumptions in order to estimate future liabilities. The assumptions are typically based on a mix of statistical studies and experienced judgment.

External auditors are contracted to audit and provide an opinion on the financial position of the the individual pension plan.

Both the actuaries and the external auditors may recommend the need to fund the plan, but, at the end of the day they are not running the show, management is.

The issues are, what is management's estimation of the rate of return and will that estimated rate of return satisfy the ultimate liability? Secondly, what is the current / historical rate of return and how does that compare to the estimate of management?

Given the balance of the current pension assets, if that estimated rate of return will not meet the obligation, then management's fiduciary responsibility is to fund the current pension asset to an appropriate level. (aka contribute cash)

Many State, local and of course corporate managers that have defined benefit plans have routinely overstated their estimated rate(s) of return on pension assets. The overstatement of the expected rate of return misstates the real funding deficit.

The motivation for doing so should be obvious. For politicians who don't want to raise taxes, are ideologically opposed to the working class, etc. make political decisions to under fund their pension plans. New Jersey would be an example: http://www.nj.com/politics/index.ssf/2015/01/how_did_nj_get_into_this_pension_mess.html

GM would just about do anything other than fund their obligations as they were underfunded by over $10 billion as at the end of fiscal 2015. However, they face enormous pressure from their workforce to live up to their obligations and subsequently issued commercial paper towards funding the shortfall earlier this year.

No doubt if ZIRP was positively changed, coupon rates would generate income and returns for pension plans, but that alone would not now or ever satisfy the under funding that has and continues to take place. http://www.nasra.org/files/JointPublications/NASRA_ARC_Spotlight.pdf As you can see from the above link, most states have made the effort to fund their obligations, irrespective of ZIRP.

The overarching reason(s) for funding deficits is the irresponsible and unrealistic use of estimated annual returns by politicians and private sector management, and the willful under / non contributions by the same characters.

Andrew Anderson said...

Yves Smith is on record for:
a) supporting government-provided deposit insurance.
b) opposing accounts for all citizens at the central bank.

But suppose we had neither a) nor b)? Then the citizens could be made exempt from negative interest up to, say, $250,000 US for their individual accounts at the central bank while non individual citizen accounts would not be exempt. I.e., monetary policy could be much more precisely tailored.

Thus Yves should blame herself if little people are getting hurt since she supports the system that does so.