Yet another policy mistake. Rate cuts are contractionary for many

Bringing back the 10p tax rate and increasing state pensions would be a more sensible stimulus

by Dr. Ros Altmann

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Today’s cut in interest rates by the Bank of England is a continuation of the Government’s misguided policy response to the global credit crisis.

Cutting rates will not ensure more lending: It did not work in Japan and it will not work here. The problem is the availability of credit, not the cost. Rate cuts seem to be a desperate, scattergun approach to the cutback in bank lending but the collateral damage they cause has been overlooked. Clearly there is a need to ensure that businesses can obtain working capital, but bringing rates down so aggressively does not ensure businesses will be able to borrow. Direct Government intervention would be better.

Easing monetary policy actually also tightens fiscal policy for many, so the effect is not clear-cut. Sharp cuts in interest rates have a negative effect on confidence. They are also the equivalent of a tax increase on pensioners – who generally have a higher marginal propensity to consume. Their income is being cut and they can do nothing about it. For example, a pensioner with £25,000 savings would earn nearly £30 a week when rates are at 6%, but this halves if rates fall to 3% and at 2% rates their income falls by two-thirds to just £10 a week.

Policymakers are ignoring millions of responsible citizens who saved for their future, in the hope that rate cuts might free up credit markets and banks might lend more! This is a dangerously unbalanced policy mix, especially in an ageing population, and must be redressed urgently.

I have two proposals:

1. Bring back the 10p tax rate, which was so shamefully abolished and damaged the lowest income groups. This could help all taxpayers. It would certainly be much more of a stimulus than a 2.5% cut in VAT!
2. Radically change the state pension and pay £140 a week to all pensioners over age 75. It will be taxed back from higher income pensioners, and will have numerous benefits. It would finally abolish poverty for the elderly, be fair to women, remove the need to force people to buy an annuity at age 75, save huge sums in administering the pension credit means test and remove the disincentives to saving that have been imposed by state pension reform. The cost would be £2billion a year – tiny in comparison with the sums thrown at the banks. It could also be funded near term by abolishing contracting-out of the state pension.

The Government’s handling of this crisis has been woefully inadequate. So far, it has included previously unimaginable increases in public borrowing, pumping billions of pounds into banks, cutting VAT (which will just add to deflation pressure and will not increase spending) and sharp reductions in interest rates.

We need broader thinking and less panic reaction with far-sighted policies to help us onto a more sustainable path of long-term recovery.

Dr. Ros Altmann – 07799 404747

ENDS

NOTES FOR EDITORS

Illustration of effect of falling interest rates on income received from £25,000 savings:

Interest rate		Annual income		Weekly income
6%		£1500		£29
5%		£1250		£24
4%		£1000		£19
3%		£ 750		£14
2%		£ 500		£10