The Bank of England’s Quantitative Easing (“QE”) programme has certainly been a hot topic in the pensions industry over the last few years. The Bank’s monetary policy of creating money ex nihilo and using this to buy up financial assets was designed to boost asset prices, lower their yields, bring down borrowing costs and promote business investment and consumer spending; all in the name of meeting the stable target for CPI inflation of 2% per annum.
Many defined benefit pension schemes may feel hard done by due to the significant fall in real yields on government bonds attributable to QE, which has caused pension scheme liabilities to balloon in recent years. Although the prices of schemes’ assets also received a boost, the aggregate impact was for deficits to widen and contribution demands on sponsoring employers to increase.
It has been argued by some commentators in the industry that QE has subsequently had a material impact on economic growth, as sponsors of defined benefit schemes have had to funnel more and more money into their schemes, at the expense of lower investment in new projects and business opportunities. The Bank’s February 2017 Inflation Report refutes this claim. In fact, by comparing nominal business investment of listed companies with deficit contributions paid between 1996 and 2015, it is estimated that “annual investment growth was on average less than 0.1% lower over that period as a result of pension (deficit) contributions”.
This may seem like a surprisingly small impact, but at the aggregate level this does make sense. These contributions are not just being fed into a black hole; they are being invested in long term financial assets that schemes must hold to back their benefit promises. In turn this means that the overall economic impact is minimal. As an example, if a pension scheme were to invest these extra contributions in an index tracker fund, the share prices of all companies that are constituents of the index will rise, leading to stronger balance sheets and higher confidence and investment. If the contributions are invested in bonds, this will increase their price and lower their yield, resulting in lower borrowing costs for other firms to finance their investments. Of course each individual DB sponsor is affected to a different extent, but overall, deficit contributions seem to have a negligible effect on the level of investment in the economy.