Thursday, November 22, 2012

Why Has The Demand For Private Borrowing Declined?

Corporations and households have decreased their demand for loans.  Demand for loans rose dramatically during the real estate bubble.  Central banks kept interest rates low, and households used their homes for collateral that enabled them to keep spending even as their income growth was  stagnant.  Rising household consumption caused businesses to invest in order to satisfy consumer demand.  Today that dynamic is no longer working.  Interest rates are low but banks are concerned about the value of the assets on their balance sheets.  Households also have a balance sheet problem.  Their homes have lost much of their value, and many are not as creditworthy as they were.  Businesses have responded to weaker demand by cutting back on investment. 

In the short term, governments might stimulate the economy by borrowing the savings that the private sector does not want to borrow.  If the money were invested wisely, the future might look brighter for the economy.  Unfortunately, that does not solve the problem that most countries are facing.  The problem is rising income inequality.  Households can't continue to fund their spending with debt.  Faced with the problem of rising inequality, capitalism has managed to survive by redistributing income.  Unless we stop redistributing income upwards to the privileged, and reverse the flow on income redistribution, it will be more difficult to deal with the tension between capitalism and democracy.

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