The Price of Money by Rob Dix

Author:Rob Dix [Dix, Rob]
Language: eng
Format: epub
ISBN: 9781804945650
Publisher: Cornerstone

New money that would normally have been created by new loans, therefore, wasn’t coming into existence. The result: deflation. If there’s not enough money to represent all the goods and services in the economy, then prices will fall. And that’s bad news. As we saw earlier, if people believe prices will keep getting lower, they might defer their spending. If they defer their spending, the drop in demand might cause more companies to go out of business, and so the spiral continues.

You could take the view that, as the crisis had been caused by everyone getting over-excited, borrowing too much money and over-consuming, the solution should be to let it all shake out: let bankruptcies happen, let businesses fail, and let the pain be felt. It wouldn’t be any fun, but it would allow the economy to rebuild from much firmer foundations once it’s all done and dusted. Of course, governments are rarely keen on the ‘feel the pain now’ option, because they could get kicked out at the next election if people are feeling unhappy about their financial lives. And on a less cynical level, you could argue that people were feeling enough pain anyway: even with an unprecedented level of government response, unemployment in the UK spiked from 5 per cent to nearly 8.5 per cent and GDP fell for more than a year.1 If otherwise viable businesses were pulled down by the chaos and a lack of intervention,2 it would make the rebuilding of the economy even harder and more government help might ultimately be needed for longer.

Faced with this unfolding disaster, the world’s central banks did the opposite of ‘feel the pain now and get it over with.’ Instead, they brought out the financial big guns – bigger guns than had ever been used before, in fact.

Most central banks cut interest rates fast – from 5.5 per cent all the way down to 0.5 per cent in not much more than a year in the UK,3 and similar in the US and the eurozone. These measures prevented many people and businesses from defaulting on loans (although plenty still did) because it drastically reduced their interest payments. Normally, you’d also expect this to increase the demand for new loans, because money had become cheaper. It almost certainly did increase demand to some extent. But it was clearly unlikely to give borrowing much of a boost. It’s hard to persuade people to borrow and banks to lend (at any price) when they’re fearful about the future of the economy.

In some countries, these radical cuts were enough to steady the economy. But in the US and UK – two countries with high levels of household and corporate debt, and which had major exposure to the financial sector that had just caused all this mess – this looked as though it wouldn’t be enough. What else could they do, though? Taking interest rates below zero wasn’t thought to be a viable option, so they’d essentially run out of firepower using their usual weapon of choice.

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