The distributional incidence of QE and lower interest rates

A new McKinsey study has crossed my desk, “QE and ultra-low interest rates: Distributional effects and risks.”  It offers a few estimates:

1. As a result of QE, governments in the US, UK, and Eurozone have benefited by about $1.6 trillion in lower debt service costs and profits remitted from central banks.

2. Households in those same countries have lost about $630 billion in reduced interest income.

3. Non-financial corporations have gained about $710 billion through lower debt service costs.

I would urge extreme caution in interpreting these or indeed any such results, as the nature of the no-QE-weaker-AD alternative scenario is hard to spell out and in any case would impose losses of its own.  “Never reason from a pecuniary externality change” a wag once told me.  Still, you can use those numbers as one example of a very rough “apply ceteris paribus assumptions to a macro problem” estimate.

One interesting takeaway from this report is that European life insurance companies may be in persistent financial trouble.  Many life insurance policies are written for 40 or 50 years but the companies cannot find assets to match those durations.  As the bonds they hold mature, they cannot easily reinvest in safe assets with yields comparable to what they are guaranteeing their policyholders.  For instance some German life insurers are guaranteeing a return of 1.75 percent, but German ten year Bunds were yielding only about 1.54 percent (the report is from November).  The insurance companies will either steadily lose money or be forced to seek out riskier investments, which is also to some extent prohibited by law and regulation.  Here is one relevant Moody’s report, which explains why German life insurance companies are especially vulnerable.  There are related readings here.

Comments

"Many life insurance policies are written for 40 or 50 years but the companies cannot find assets to match those durations. ... For instance some German life insurers are guaranteeing a return of 1.75 percent."

Current yield on a 30-year German bond: 2.75%

I fail to see the issue here.

Yields on German 30 year is less than 1%. Bloomberg a few moments ago.

I'm seeing 2.757% on CNBC, unless I'm misunderstanding something.

They didn't lock in with those in the earlier years, that is one key point.

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Isn't another figure needed for the full picture? How much have households gained from lower debt service costs?

It's net interest income:

"Meanwhile, households in these countries together lost $630 billion in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income."

Finally, score one for Millennials.

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Public policy is about trade-offs. Ultra low borrowing costs are offset elsewhere in the economy. The American balance sheet has winners and losers from the current arrangements. If you were banking on the pension your union promised, you will be a loser. if you are in the money game, then you have been a winner. The political class has been a big winner as a generation of them have avoided the terrible choices that inevitably come with socialism. Somewhere down the road, when all of this has to reversed out of the system, we will get a whole different set of winners and losers.

What's interesting to me is how much of the big picture is driven by demographics i.e. the baby boomers...the primary issue facing our federal government and the funding thereof is entitlements, and because voters like entitlements, they aren't going away. But how do you/we pay for them with that huge bulge of people getting into prime medical spending age in 10-20 years?

It's not really an ideological issue to me, except in how you potentially solve it. We as a nation consist of 317 million people. A large portion of that 317 million is getting into the older age categories, proportionally a larger group than we've ever seen. Those people need to be 'handled', meaning they will require food to eat, and shelter, and medical care. How will they be? We'll soon see...

I'm not sure we'll see some massive 'reversal' out of the system, the system will evolve as it always has, with plenty of arguing and dislocation and challenges along the way.

See Detroit

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" A large portion of that 317 million is getting into the older age categories, proportionally a larger group than we’ve ever seen. Those people need to be ‘handled’, meaning they will require food to eat, and shelter, and medical care. How will they be? We’ll soon see…"

There's only one logical answer, everything else is hand waving and wishful thinking. The effective retirement age will go up. There is no way that baby boomers are going to be able to retire en masse at 65-67 years old. The math just doesn't add up. Social Security won't support it and most baby boomers haven't saved much extra for retirement.

Re: raising retirement ages

What about plumbers and laborers? We have retirement ages for a reason - the 65+ body can't do certain jobs
Do you really want a 65+ teacher educating your kids or would you prefer someone a little *ahem* fresher? What kind of jobs are suitable for someone who is 70?
Technology and globalization are whacking away jobs - lowering the retirement age in order to curtail the labor force and get more young people working is more likely (to me) than raising the retirement age

With regard to her friends who don't have retirement savings, my mother asked me "why can't the government just print more money?"

60+ year old teachers I've had have been on average way better than the 20-something teachers I've had. One data point, for what it counts.

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Instead of fighting in South Vietnam in the 1960's, we should have been colonizing the place. Imagine if we had shipped off 15 million boomers to setup shop in Vietnam, Laos and Cambodia. Alternatively, instead of Vietnam we sent help to Rhodesia along with 20 million pioneers.

Rhodesia had a more equable climate. They also spoke English there.

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Yes, the governments benefit while savers suffer together with life insurance companies. It was easy to target savers as they have nowhere else to go.

"the nature of the no-QE-weaker-AD alternative scenario is hard to spell out and in any case would impose losses of its own."

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Long-term bond yields were not the largest near-term threat to life insurance companies.

The crashed equity markets were the problem. The LI's had huge risks with the GICs they sold. Insurers with good investing records (Berkshire comes to mind) had enormous amounts of reserves tied up in equities. Pumping up equities while suppressing long bond yields was a double win for insurers, and a big loser for households with savings...other than those that had grabbed a GIC play.

Other winners: households with savings in equities (401k or otherwise)...or equity (in their homes)

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Oh, my God, I got my maturities wrong. Someone will have to bail me out.

Where does the risk shifting end? How can it be ended?

Good luck for 2014, which promises about as much risk as previous years, perhaps more or less. :-)

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Which is more troublesome: German life insurance companies guaranteeing an 1.75% return, or state and local government pension systems guaranteeing 7.5% return?
http://online.wsj.com/news/articles/SB10001424127887324100904578403213835796062

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I'd be wary of a McKinsey study on Macro. Hell, most McKinsey studied don't even have a proper equation in them forget calculus.

Actually, I place exactly the same faith in McKinsey's output as I do the Mercatus Center's - with or without a single equation.

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Ummm, how can these three effects be a complete analysis without the net harm to a subset of people from foregone deflation?

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