The cost of credit: accounting for differences in the ability of households to pay
Economists at UCL argue that inequality should be considered when regulators intervene in ability of financial institutions’ to provide credit
7 October 2020
Since the Global Financial Crisis in 2008, economists have been exploring how certain imperfections in financial markets affect the world’s economies. The effect of ‘cost of borrowing’ decisions on the business cycle have been closely examined. But the impact of these decisions on individual households has not been assessed until now.
“Current thinking among economists highlights the impact of imperfections in the credit system on the economy as it goes through periods of recession and boom. But existing models do not consider the impact on individual household’s ability to avoid financial hardship,” explains Dr Ralph Luetticke, (UCL Economics).
Since 2009, banks have been more closely regulated to help reduce volatility in financial markets and the economy in general. However, this regulation comes at a price: the banks have to charge more for credit and this increases costs for businesses and individual households alike.
“Existing models do not consider the impact on individual household’s ability to avoid financial hardship.”
Depending on their financial outgoings, and whether or not they have savings or other assets, households vary greatly in their ability to withstand economic shocks, such as unemployment. Many have to rely on credit cards and loans.
Economists Dr Luetticke and his departmental colleague Professor Morten Ravn wanted to develop insights to allow a deeper understanding of financial regulation and its interaction with inequality.
Their analysis points towards potentially unintended consequences of the attempts to stabilise the economy as a whole through financial regulation,” Dr Luetticke explains. “What we see is that banking regulation can prevent some households from accessing the credit they need to weather their own financial storms.”
Their new model will help central banks and financial bodies sharpen their insights and develop policies that better address the trade-offs between economic volatility and individual’s financial volatility.