Rate cuts could make the economy worse, not better

by Dr. Ros Altmann

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We have just had another desperate bid to kick-start our economy, with base rates being cut to an unprecedented 1.5%. The Government says lower rates are essential to get things moving again and that this is the right thing to do. Wrong!

It is a grave mistake to push rates down so low. Panic rate cuts from already very low levels will make little or no difference and may even make our economic difficulties worse, not better.

Cutting rates is supposed to help increase borrowing and make repayments more affordable, which should support economic activity. Also, if banks can borrow money more cheaply, they should be able to lend more cheaply. That sounds good in theory doesn’t it?

But, in practice it’s just not that simple. In my view, cutting rates to these crazily low levels will not stimulate the economy and could actually damage it. When people see the Government bringing rates down again and again, they feel a sense of panic and think twice before spending. Also, when people earn less on their savings, they will spend less. At 3%, rates were quite low enough to provide some stimulus, but at 1½ %, they are damaging. Japan brought its rates down to zero but that did not help its economy and it won’t help ours either.

When a patient is sick and the medicine does not seem to be working, the sensible doctor will either change the treatment, or give things time to work. However, the Government just keeps on doubling the dose in the desperate hope it will suddenly work, when evidence suggests otherwise. Medicines have side effects and pumping more and more into the patient could kill rather than cure.

Disgracefully, in its misguided panic attempts to help the economy, the Government is hurting millions of people, particularly pensioners, who deserve better treatment. Many ordinary, hard-working citizens who put money aside to supplement the disgracefully low state pension (it is the lowest in the developed world!) are being damaged by cutting interest rates.

This has the same effect as cutting the state pension! Nobody would suggest that is a sensible policy, but as it is happening behind the scenes the Government gets away with it. The reduction from 5% to 1.5% in just 3 months is like a £10 a week cut in the state pension for every £15,000 that someone saved. If they have £30,000 of savings, this is like cutting the state pension by £20 a week!

But it is even worse than this. Because the Government is also robbing many of these pensioners of their pension credit. It has refused to recognise that their savings income is cut.

Pension Credit means-tests do not look at the actual amount people earn on their savings, but look at how much savings they have and then just assume people are earning 10% a year (yes, 10%!) interest to calculate their income. Even after recent rate cuts with many savings accounts paying less than 1% interest, the 10% assumption remains, Government says their income is much higher than it is and, therefore, does not pay them the right benefits. This is forcing pensioners into poverty.

It is a disgrace and it MUST change urgently. I call on all MPs to insist that the Government adjusts pension credit payments immediately to reflect the dramatic reduction in interest rates and alleviate some of the damage it is causing to savers. Pensioners are spenders, not savers, they need their money to live on and any cuts in their savings income will cut their spending too. There are around 8 million pensioners with savings and as they cut spending, this will damage economic growth.

So, if interest rate cuts won’t work, what could we do? Let’s look at the problem. The economic crisis was caused by banks lending far too much to businesses and households who cannot repay. They also invested depositors’ money in complex financial instruments that turned out to be worthless. Again, theoretical models said there was little or no risk, (just as models today say rate cuts will stimulate spending) but it was not true in practice. Billions of pounds were thrown away, but noone noticed until it was too late. The Government’s financial Regulator was asleep at the wheel. It allowed banks to lend irresponsibly and to reward their staff just for issuing more loans, with no concerns about repayment. So there was little or not regulation on lending, but draconian rules for investors. Financial advisers were drowned in red tape when trying to sell pensions.

Of course, all of this was great for the economy. Lots of borrowing, banks reporting huge (fictitious) profits, bankers making millions and everyone spending rather than saving – no wonder growth was strong. On top of that, the Government itself borrowed huge sums by expanding public spending way beyond its revenues. Much of our growth was based on borrowed money, so we have been living beyond our means for years and cutting back is painful. This is the problem we are trying to deal with.

We need a carefully thought out and better-targeted response to this crisis, rather than panic measures that could make things worse. If we want to get loans to businesses, then we must do so directly, rather than throwing money at the banks and cutting rates in the hope that something might start to happen.

The Government must help pensioners NOW. It must adjust pension credit payments to reflect the fact that nobody is earning 10% interest on their savings and to undo some of the damage that has been done by lower rates. Forcing pensioners into poverty is not a decent way to behave and as our population ages, it is vital that we encourage, rather than punish savers.