Repaying ourselves into recession
Have the laws of supply and demand been repealed? Interest rates have come down, yet borrowing has fallen.
Outstanding debt for both companies and individuals fell in August 2009 for the first time since records began. However, as records have been kept only since the 1990s, they do not cover a period of recession and the decline in borrowing may well reflect changed attitudes to credit when the outlook looks bleak. During booms we borrow, confident we can repay debt from future income; in slumps we worry about the income and reduce our debt.
So the economic laws have not been abolished; we have moved to a new, lower, demand curve at which the same interest rate means we want to borrow less (or a lower interest rate does not make us want to borrow more).
Borrowers may be showing a belated restraint therefore. Or they could have had this new scenario thrust onto them.
There is evidence of people shunning high-cost credit-card debt, but the outstanding amount of card borrowing was falling even before the credit crunch. More likely, the £600m fall in the £1,450bn of personal debt reflects homeowners who maintaining their monthly mortgage payments even though interest rates have fallen and their overpayment is thus paying down capital.
(Wily mortgage providers would have insisted on borrowers with low equity doing that anyway instead of cutting their payments - or at least would have encouraged it by passing on lower rates only to those that use the difference to reduce their loan. But that’s another issue.)
For corporations, the £8bn repaid in August reflects cost savings and reduced capital expenditure because of concern over future revenues. But it also reflects the continuing difficulty in obtaining loans and the fact that the cost of money has not necessarily fallen because lower base rate are offset by increased margins above base.
So whatever has happened to companies’ demand curves for debt, the supply curve has moved too. A higher supply curve means that less money is on offer for the same price as before, and that discourages firms from borrowing.
But theoretical economics aside, the fact remains that the government’s pressure on banks to lend and the Bank of England’s quantitative-easing programme seem to have failed to work and Britain has a shrinking economy. Repaying debt means less spending and that prolongs the slump.
