In the short term, inflation may matter more Rising inflation is having a greater impact on economic growth than the credit crunch It is fashionable to talk about the “credit crunch” as the cause of all the UK economy’s ills.
In the short term, inflation may matter more Rising inflation is having a greater impact on economic growth than the credit crunch It is fashionable to talk about the “credit crunch” as the cause of all the UK economy’s ills. There is no doubt that a tightening of credit availability has contributed to weaker consumer and investment spending growth. But the simple point often overlooked is that the sharp rise in inflation over the past year – quite a separate issue from the credit crunch – is having an even bigger downward impact on economic growth. We argue that the credit crunch is having a
significant negative impact specifically on individuals and companies which are highly leveraged and perceived bym lenders to be higher risk. In contrast, we believe that the unexpectedly sharp rise in inflation, due to higher food and energy prices, is having a much more generalised downward impact on domestic demand because it reduces consumers’ real income growth and firms’ profit margins.
Although credit availability has fallen, this is not the main reason for reduced capital expenditure Focusing on the corporate sector, business investment spending contracted in Q2 by 1.9%, after falling 1.8% in Q1, according to official data.
Was this mainly a result of the credit crunch?
The evidence does not support this. Although banks have tightened lending standards in the past year, the latest quarterly CBI industrial trends survey shows that only 5% of respondents to the survey said the “cost of finance” was a factor likely to limit capital expenditure and only 4% said “inability to raise external finance” was a factor. Instead, the survey indicated that 55% of respondents said that “uncertainty about demand” was a factor limiting capital expenditure, up from 44% a year ago, as chart a shows. In fact, chart b shows that the cost of finance was a much more significant factor constraining investment in the early 1990s recession.