Forcing people to save more in their pension pot could help reduce inflation
5 min read
Earlier in the year optimistic voices suggested that inflation would be transitory rather than sticky.
While prices drop in the United States and the Eurozone, the United Kingdom is not faring so well. It's a problem that's pervasive and regressive, hitting those who can least afford it the hardest.
The current weapon against rising costs is to raise interest rates. The theory, in terms of how it applies to ordinary people, is simple: squeeze the disposable income of borrowers and make saving more attractive thereby reducing demand in the economy and leading to lower prices. But interest rates are a blunt instrument. The effects on the public tend to fall on relatively few shoulders.
We need to be creative about how we deal with high inflation without doling out financial ruin on an unlucky few
Only around 30 per cent have mortgages, and a historically high proportion of these are fixed rates – more than two million fixed-rate deals will expire before the end of 2024. The pain is highly concentrated on a subset of homeowners who have floating rates, are unlucky enough to have their fixed rates come up for renewal, and on businesses that have higher levels of unfixed debt. The pain also bleeds through to many unlucky renters as landlords pass on interest increases via rent payments.
In short, our strategy to reduce inflation arbitrarily heaps pain on those who are economically in the wrong place at the wrong time; it rests on the bad luck of millions. So, what's the alternative?
We need to find a way to reduce demand in a more equitable way, without causing needless and disproportionate hardship.
Well, let’s first focus on the primary goal, to reduce inflation through suppressed demand in the economy. There’s also a secondary goal which is to boost saving.
One interesting idea is forced saving – mandating an increase in savings for some people in the population and therefore constraining their immediate spending – an idea that has roots in the theories of the famous economist John Maynard Keynes. This could be an effective way to reduce demand, but which mechanism should this saving occur through?
In the UK this could most easily be implemented through increased pension contributions. Or even better, from a behavioural point of view: an opt-out increase in pensions contributions. This could be done on a sliding scale, with those earning the most defaulting in to contribute more to their pension and those earning the least contributing less.
This approach has several advantages.
Firstly, it could be deployed in a fairer and less random way than interest rate rises hitting mortgages. There would be lower risk of catastrophic financial consequences for individual hard-working families with the bad luck of having their fixed rate run out. And it could of course have much wider coverage and therefore efficacy.
Second, it would be quickly implementable and enforceable through the pension schemes that all employers have had to offer as part of the rollout of auto-enrollment pensions since the 2008 Pensions Act.
Third, it would contribute to the long-term financial stability of both individuals and the country through increasing pension contributions. And those who really couldn’t afford it could opt out. Policy-makers consistently underestimate the power of such opt-out provisions: due to auto-enrolment over £33bn more was saved in 2021 than in 2012. The rate at which the increased pension contributions would need to be set in order to have sufficient impacts on aggregate demand and whether people would opt out or not in these circumstances are things that should be tested and monitored with any policy rollout.
Finally, the increased capital for pension funds may flow into increased investment. This is itself a highly desirable objective to help boost the UK’s medium to long-term growth. The UK economy is starved of investment: it is estimated that the UK is around £110bn a year below the investment levels, relative to our GDP, of the United States and Germany. A more radical alternative to using pension increases, that has a more direct link to investment, is to use a forced savings mechanism to take consumer demand out of the economy and channel the savings into a citizens wealth fund to invest in net zero infrastructure with long-term profits flowing back to people across the country.
We need to be creative about how we deal with high inflation without doling out financial ruin on an unlucky few through a crude and indiscriminate mechanism. Increased default pension saving rates obviously won’t solve inflation alone – not least given interest rate rises operate through a variety of routes and not just by constraining consumer spending – but using it as part of our toolkit could help address the random inequality that interest rate rises create.
Mandatory higher default pension contributions, designed in a progressive way, could meet a variety of policy objectives – reducing inflation by taking spending power out of the economy, ensuring any economic pain from this is distributed more fairly, and increasing our economic investment and social resilience to our ageing population through higher pension contributions.
Ben Szreter, senior policy advisor at the Behavioural Insights Team
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