Civil Engineering Reference
In-Depth Information
In turn dealings in the interbank market affect the interest rates adopted in the
wider economy by all other credit agencies and financial institutions, such as the
high street banks. No bank would lend to customers at a lower rate than the one
at which it borrows, as it is in business to make a profit not a loss. So, when banks
find themselves facing more difficult economic times, they tend to increase the rates
charged on their loans and they might even decide to ration the quantity of credit
they are willing to extend - in effect, both these actions were captured in the phrase
credit crunch
. More importantly it sowed the seed that triggered the financial crisis
that dominated the headlines from 2008 to 2012, and this is explained further in the
next section.
Key Points 14.2
❍
Demand-pull inflation occurs when the total demand for goods and
services rises faster than the rate of growth of supply.
❍
Cost-push inflation is due to one or more of the following: (a) wage rises,
(b) widening profit margins, and/or (c) raw materials price increases.
❍
Prices and incomes policies, control of money supply and managing interest
rates have all been used as attempts to reduce inflationary pressures.
THE CREDIT CRUNCH
The so-called credit crunch emerged from instability in the US mortgage markets
during 2007, where a combination of rising interest rates and falling house prices
had exposed poor quality lending, which led to a sharp increase in mortgage
defaults. Subsequently a period of panic struck financial markets across Europe
and America; uncertainty spread, loan defaults increased, liquidity evaporated,
and central banks were called upon to throw financial lifelines and introduce new
instruments to keep many institutions afloat. The over-riding problem was that
banks had insufficient capital to meet their obligations, and a significant number
of American and European banks and mortgage lenders were forced into protective
mergers, nationalisation and even bankruptcy. In fact, Countrywide, Fannie Mae,
Freddie Mac, Bear Stearns, Lehmans, Merrill Lynch, Northern Rock, Alliance and
Leicester, HBOS, Bradford and Bingley, KSF, Dexia and Bankia all fell victim to the credit
crunch debacle.
The surviving banks and building societies tightened lending criteria and raised
their rates of interest despite the fact that central banks such as the Bank of England
cut their rates several times. This action was unprecedented as the usual practice
is for bank interest rates to mirror adjustments and certainly to move in the same
direction as changes made to the official (repo) rate - and usually on the same day.
Between 2008 and 2012 however, institutions in the financial market did not react
to repo rate changes in this way; they began to revise their margins and increase
the costs of borrowing to move to a new market equilibrium. In short, the financial
crisis represented a period of time when global financial markets sought correction.
