Banks with robust balance sheets are eager to lend into such an environment.
A build up of debt relative to savings often marks the period of an economy entering the mature phase, and is also the point at which central banks try to tighten monetary policy.
Higher interest rates should have the effect of dissuading borrowers and encouraging saving, rather than spending.
Additionally, higher interest rates actually act as a disincentive for banks to lend, as they can simply place the money in government bonds and receive the higher interest rate there, without having to take the risk of lending into the real economy. This has the effect of lowering inflation, as the amount of cash being created in the real economy reduces.
Guy Miller, chief strategist at Zurich, says the problem faced by clients now is not that rates are rising due to the economy “going gangbusters” and policymakers wish to slow the supply of money to prevent a credit crisis, but rather because inflation is too high.
Squeezing the supply of money in the economy does not serve to reduce energy prices, but it does reduce the level of aggregate demand in the economy.
This would be expected to lead to a material slowdown in economic growth, according to Miller, but he does not think it will cause a recession any time soon.
He adds that emerging economies have already undertaken their process of raising interest rates and having GDP slow down, and it may be that those economies begin to grow just as other parts of the world are slowing down.
In such a scenario, emerging economies could also contribute to higher growth in developed economies.
Velocity of money
In addition to attempting to manage the supply of money, policymakers also attempt to understand the velocity at which the money already in circulation moves through the economy.
Put simply, cash under the mattress has zero velocity, and is deflationary, while every other purpose to which cash can be put has some velocity.
The speed at which each physical banknote moves through the economy is an example of velocity. Individuals who save a high proportion of their income are therefore slowing the velocity of money relative to someone who immediately spends all of their salary.
Generally speaking, the quicker the velocity of money, the higher the inflation rate and GDP growth rate in the economy.
John Chatfeild-Roberts, who heads the team that runs the Merlin fund range, says the policy of quantitative easing, which is designed to increase the money supply, may actually slow the velocity, as the higher house prices it engenders results in young people having to save, rather than spend, a larger portion of their income.
