tag:theconversation.com,2011:/africa/topics/borrowing-4315/articlesBorrowing – The Conversation2024-01-03T17:41:33Ztag:theconversation.com,2011:article/2186782024-01-03T17:41:33Z2024-01-03T17:41:33ZMortgage rates are falling but borrowers are still feeling the squeeze – a finance expert explains how to cut your repayments<figure><img src="https://images.theconversation.com/files/567069/original/file-20231221-15-qtv8aw.jpg?ixlib=rb-1.1.0&rect=25%2C8%2C5582%2C3682&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/unhappy-depressed-young-africanamerican-couple-calculating-592973699">Cast Of Thousands/Shutterstock</a></span></figcaption></figure><p>Around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023#downloads">5 million households</a> have seen their mortgage interest rate change since the Bank of England base rate started to rise in late 2021. Over the course of the 2023 alone, the base rate increased from <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">3.5% to 5.25%</a>, surpassing <a href="https://www.ft.com/content/955b568a-c924-421a-bc0f-caa85d37007b">economists’ expectations</a> and pushing mortgage rates to the highest levels since 2008. For some people, repayments have increased by hundreds of pounds overnight.</p>
<p>Many people facing increased monthly mortgage payments were already managing stretched budgets due to the rising cost of living. Inflation for households with mortgages is estimated to be the <a href="https://www.ft.com/content/3d1b54dc-c0bf-4dd7-9c11-054eba3160c1">highest for any socio-economic group</a>.</p>
<p>Some households have chosen to reduce the pressure by remortgaging over a longer term. Mortgages of <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023#downloads">35 years or more</a> have increased from around 5% to 12% of the market in the last two years. What’s more, 28% of new owner-occupier mortgages were agreed on terms longer than 30 years. </p>
<p>People that want to get on the property ladder – particularly millennials, the oldest of whom are now reaching their mid-30s – are instead being forced to continue to rent, even as rents <a href="https://www.theguardian.com/money/2023/dec/11/tenants-in-britain-hit-by-highest-increase-in-rent-for-a-decade-last-month?ref=biztoc.com">soar by 10.2%</a>. The resulting drop in demand for homeloans can be seen in the figures for new mortgage approvals for home purchases, which averaged around 47,000 per month in 2023 (as of October), well below the pre-pandemic average of 65,000 approvals. </p>
<p>Total mortgage lending fell by 25% in 2023 and <a href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">is not expected to recover in 2024</a>.</p>
<p><strong>Mortgage lending has fallen recently</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Bar chart showing mortgage lending falling recently." src="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=278&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=278&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=278&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=349&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=349&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=349&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">Author provided using data from UK Finance</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
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<h2>Where are rates headed in 2024?</h2>
<p>Signs that households are struggling to keep up with mortgage payments are getting stronger, with <a href="https://www.ftadviser.com/mortgages/2023/12/07/more-homeowners-falling-into-mortgage-arrears/">more people now falling into arrears</a>. Although less severe than previously forecast, industry body UK Finance expects arrears and possessions to <a href="https://www.ukfinance.org.uk/system/files/2023-12/Household%20Finance%20Review%202023%20Q3.pdf">continue to rise</a>.</p>
<p><strong>Arrears and repossessions are rising</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing arrears rising recently (blue bars) and repossessions (red line)." src="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=282&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=282&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=282&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=355&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=355&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=355&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">Author provided using data from UK Finance</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
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<p>And as more homeowners come off the cheap fixed rates of pre-2022 period, around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023">2.3 million households are expected to face higher rates in 2024</a>, with an average monthly repayment increase of £240. The Bank of England has forecast that around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023">440,000 households will struggle to afford</a> these increases. </p>
<p>There is some good news: <a href="https://www.investopedia.com/terms/i/impliedrate.asp#:%7E:text=The%20implied%20rate%20is%20an%20interest%20rate%20equal,that%20also%20has%20an%20option%20or%20futures%20contract.">market expectations</a> are for the Bank of England base rate to fall. It is expected to ease to around <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/november-2023?ref=pmp-magazine.com#report-november">4.25% by the end of 2026</a>, from 5.25% right now. So, we may well have <a href="https://www.nationwidehousepriceindex.co.uk/reports/house-price-recovery-continued-in-november#:%7E:text=significant%20change%20in%20market%20expectations">passed the peak</a> for interest rates.</p>
<p><strong>Expectations for the Bank of England base rate are changing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing changing expectations for the Bank of England base rate." src="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=333&fit=crop&dpr=1 600w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=333&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=333&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=418&fit=crop&dpr=1 754w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=418&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=418&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.nationwidehousepriceindex.co.uk/reports/house-price-recovery-continued-in-november">Nationwide House Price Index, using Bank of England data</a></span>
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<p>Mortgage rates (which are generally tied to the base rate) have already dropped since September, when the <a href="https://edu.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2023/monetary-policy-summary-and-minutes-september-2023.pdf#:%7E:text=The%20Bank%20of%20England%E2%80%99s%20Monetary%20Policy%20Committee%20%28MPC%29,of%205%E2%80%934%20to%20maintain%20Bank%20Rate%20at%205.25%25.">Bank of England decided to hold</a> the base rate as inflation slowed. In early January, Halifax cut some rates by nearly 0.8% and HSBC also announced reductions for certain products. Mortgage <a href="https://www.bbc.co.uk/news/business-67873017">brokers believe</a> this could encourage more rate cuts by other lenders.</p>
<p>Rates still remain high compared to recent years, but this downward trend will continue to help household finances this year. For the average <a href="https://www.statista.com/statistics/915977/average-value-of-mortgage-granted-in-the-united-kingdom/">£200,000 mortgage</a>, for example, a 1% drop from 5.8% to 4.8% would lead to yearly savings of around £2,000.</p>
<p>But it’s unrealistic to expect the mortgage rates to return to the <a href="https://theconversation.com/why-mortgage-rates-will-not-return-to-recent-lows-any-time-soon-201619">325-year lows</a> observed between 2008 and 2021. Furthermore, a third of the Monetary Policy Committee – the team that decides what the Bank of England base rate should be – are still <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/december-2023">keen to increase the base rate</a> to meet the Bank of England’s <a href="https://edu.bankofengland.co.uk/explainers/what-is-inflation#:%7E:text=A%20low%20and%20stable%20rate%20of%20inflation%20helps,England%20job%20to%20keep%20inflation%20at%20that%20target.">2% inflation target</a>. The current level of inflation is <a href="https://www.ons.gov.uk/">4.2%</a>. </p>
<p>So, UK homeowners may not be out of the woods yet. Further rate cuts will depend on the future course of inflation, which is difficult to predict because it’s influenced by many external factors – energy and food prices can be affected by wars and other global crises.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">Five ways to reduce your mortgage repayments in 2023 – and why rates have risen so high</a>
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<h2>What to do if you need a mortgage in 2024</h2>
<p>To start with, consider seeking advice from a qualified, independent mortgage advisor. They can discuss your personal circumstances with you. They also may have access to better deals than you can find yourself online or through your bank.</p>
<p>If you are a first-time buyer, since the Bank of England is expected to hold rates for now, it may be sensible to wait for rates to ease a bit more. During this time, save as much as you can towards your deposit. Both will help to reduce your borrowing costs. However, there is always the risk that rates and inflation stop falling or slowing due to unexpected changes in the economic and political environment.</p>
<p>If your budget is tight and you are worried about affording increased repayments in the future, extending your mortgage term would reduce monthly payments. But it will take longer to pay off your mortgage as a result. You may be able to make <a href="https://www.moneysupermarket.com/mortgages/mortgage-overpayments/">overpayments</a> in the future to catch up if your financial situation changes, but this is typically limited to 10% of the balance per year.</p>
<p>Another alternative is to temporarily switch to <a href="https://www.unbiased.co.uk/discover/mortgages-property/buying-a-home/what-is-an-interest-only-mortgage-how-do-repayments-work">interest-only repayments</a> for a couple of years. This means you are not paying off the money you have borrowed, just the interest. Once the rates are lower you can switch back to a repayment mortgage. But again, this will lengthen the time it takes to pay off your mortgage.</p>
<p>If you are on a fixed-rate mortgage that is about to end in 2024, make sure to check your lender’s standard variable rate (SVR). This is the rate you will automatically move on to if you do not remortgage. But SVRs are often the highest rates around, so it may be best to look for a better deal before your current rate ends.</p>
<p>If your home is one of the <a href="https://www.gov.uk/government/statistics/help-to-buy-equity-loan-scheme-data-to-30-september-2022/help-to-buy-equity-loan-scheme-data-to-30-september-2022">375,654 properties</a> bought via the government’s help-to-buy loan scheme, check how much you will be charged if you continue with your current deal. The rates under these schemes can be more <a href="https://www.moneyhelper.org.uk/en/homes/buying-a-home/help-to-buy-scheme-everything-you-need-to-know">competitive than normal market rates</a>. However, keep in mind that you will share any future capital gain with the government if your home increases in value as the scheme owns a share of it (typically a maximum of 20%). </p>
<p>Recently, the UK’s mortgage lenders agreed with the government on a number of measures <a href="https://www.gov.uk/government/news/chancellor-agrees-new-support-measures-for-mortgage-holders">to support people struggling</a> with their mortgage repayments. So, if you are worried, it’s best to talk to your bank in advance about how it can help.</p><img src="https://counter.theconversation.com/content/218678/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Homeowners looking to remortgage and first-time buyers struggled to manage interest rate hikes in 2023. Here’s what to think about this year.Alper Kara, Professor of Banking and Finance, Brunel University LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2171442023-11-13T16:36:50Z2023-11-13T16:36:50ZYoung people’s reluctance to talk about money is putting them at risk – here’s how to help them<figure><img src="https://images.theconversation.com/files/559048/original/file-20231113-29-3i07wn.jpg?ixlib=rb-1.1.0&rect=0%2C2%2C1000%2C663&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/couple-managing-debt-1050973406">Rawpixel.com/Shutterstock</a></span></figcaption></figure><p>Credit is an everyday, and <a href="https://www.cambridge.org/core/journals/journal-of-social-policy/article/abs/lived-experience-of-financialization-at-the-uk-financial-fringe/313183E8F34A47D046127DC416B88F8F">often essential</a>, part of young people’s lives. Gaining access to credit for the first time is an important transition to adulthood that can enable you to study, earn and invest in your future. </p>
<p>Previously, most people’s first taste of debt was either a loan for university fees, a student overdraft or a credit card. Younger generations are now <a href="https://www.statista.com/statistics/1181682/bnpl-user-age-in-uk/">much more likely</a> to use new forms of credit such as buy now, pay later (BNPL) – a kind of credit often offered at online check-outs that allows people to borrow the cost of their shopping and repay it in instalments.</p>
<p>But confusion about <a href="https://journals.sagepub.com/doi/10.1016/j.ausmj.2011.05.007">the long-term consequences of building up debt</a> is common – and is often compounded by a reluctance to talk about money and debt. This is deeply problematic. Decisions about credit can affect financial wellbeing now and in the future. </p>
<p>I recently worked on a project about <a href="https://www.financialfairness.org.uk/en/our-work/publications/young-peoples-borrowing">young people and borrowing</a> with my colleague Hussan Aslam, which was funded by the charity <a href="https://www.financialfairness.org.uk/">abrdn Financial Fairness Trust</a>. We interviewed 80 young people (aged 18-24 years old) across the UK about money. Almost two-thirds see money and credit as taboo topics. </p>
<p>This attitude stops people from talking openly and learning about debt and finance. One person we spoke to said:</p>
<blockquote>
<p>I’ve always felt in society it’s a taboo subject that people don’t really talk about that often, and when you do bring it up everyone’s a little bit sheepish to talk about it, so … where do you get the information from? It’s not something you’re just born knowing … and if you do research online there’s an overwhelming amount of different information.</p>
</blockquote>
<p>This confusion around credit and borrowing is a problem, particularly for young people who are at the start of their financial lives. But your experience of credit as a young person – both good and bad – can influence how you manage your money for the rest of your life. </p>
<p>Research shows young people are often especially <a href="https://onlinelibrary.wiley.com/doi/10.1111/j.1467-9515.2010.00731.x">financially vulnerable</a> in this respect due to limited financial know-how or experience. So getting support to get the best out of credit can help people avoid common pitfalls. </p>
<p>People don’t always know where to go for <a href="https://www.moneyhelper.org.uk/en/family-and-care/student-and-graduate-money/supporting-yourself-financially-a-guide-for-young-adults-aged-16-to-24">support online</a>, which makes it difficult to gain the knowledge to make good financial decisions. Also, the financial products that are often marketed to young people – buy now, pay later deals, for example – may <a href="https://journals.sagepub.com/doi/10.1177/03128962211032448">help them feel more in control</a> of their money, but can actually promote irresponsible financial habits.</p>
<p>Such short-term financial decision making doesn’t always result in the most rational outcomes for longer-term financial wellbeing. The subscription-style of BNPL offerings can obscure the fact that it’s a form of debt and make the product appealing to young people, especially when used online at the point of sale. </p>
<p>There was little understanding among <a href="https://www.financialfairness.org.uk/en/our-work/publications/young-peoples-borrowing">the people we spoke to</a> about how credit use, including mobile phone contracts and BNPL, could affect their credit history if they were unable to repay the loan.</p>
<h2>How to help young people</h2>
<p>Many of the organisations people interact with – from financial services firms to employers – could do more to support people that want to use credit responsibly. For example, products and services from banks and fintechs could help people keep better control of their finances. </p>
<p>For younger people, this could include no or low-interest overdrafts when graduating from an interest-free student overdraft, for example. Recent “consumer duty” regulations by the <a href="https://www.fca.org.uk/publication/policy/ps22-9.pdf">Financial Conduct Authority</a> should help to ensure firms better inform and support consumers using credit and other financial products.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-new-consumer-duty-rules-for-financial-products-could-reduce-debt-related-stress-210169">How new 'consumer duty' rules for financial products could reduce debt-related stress</a>
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</em>
</p>
<hr>
<p>Financial services and financial technology firms can also play a role in boosting responsible use of credit by using the data they hold for good to help young people manage their money effectively. </p>
<p>For example, <a href="https://www.financialfairness.org.uk/en/our-work/publications/young-peoples-borrowing">young people want</a> more products and services that help them control their credit and money. Traditional banks and lenders could learn from fintechs by developing apps to help people actually visualise their finances. </p>
<p><a href="https://www.fincap.org.uk/en/reviews/helping-those-who-use-credit-to-make-ends-meet">Research shows</a> the pandemic and cost of living crisis have significantly influenced credit use. So, policy and practice by governments, regulators such as the Financial Conduct Authority, lenders, educators and advice providers such as the Money and Pensions Service (MaPS) must acknowledge the role that credit plays in helping people to make ends meet. </p>
<p>They could help find better ways to support financial decision-making as people transition to financial independence. </p>
<figure class="align-center ">
<img alt="A row of people on phones, emoticons." src="https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=340&fit=crop&dpr=1 600w, https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=340&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=340&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=427&fit=crop&dpr=1 754w, https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=427&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/559050/original/file-20231113-27-yjn9zw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=427&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Younger generations often seek financial advice online.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/people-watching-video-live-streamings-1338120284">Rawpixel.com/Shutterstock</a></span>
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<p>Promoting trusted sources of advice would help here, rather than leaving people to rely on self-styled social media “<a href="https://www.asa.org.uk/news/asa-partners-with-fca-and-sharon-gaffka-to-educate-influencers-around-finfluencing.">finfluencers</a>”. Almost half of the young people we spoke to were influenced by social media to use credit or manage their money in a particular way. </p>
<p>The FCA and MaPs could develop more resources on relevant social media sites such as TikTok and Instagram, or other media platforms used by young people. They could create explainer videos on key topics that would help support young people who are considering using credit for the first time. </p>
<p>They could also use it to <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4216952">track and correct</a> new trends or incorrect assumptions about money among this age group.</p>
<p>Regulating <a href="https://theconversation.com/buy-now-pay-later-how-to-protect-consumers-without-regulating-it-out-of-existence-184761">buy now, pay later</a> schemes would also be a step in the right direction. The financial services sector needs to take greater responsibility to ensure good outcomes for everyone because financial decisions made today could last a lifetime.</p><img src="https://counter.theconversation.com/content/217144/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lindsey Appleyard receives funding from abrdn Financial Fairness Trust. She is a Director of CreditU, a marketing platform which promotes UK Credit Unions.</span></em></p>Taboos around talking about money can prevent people from learning important lessons about using credit and getting into debt.Lindsey Appleyard, Assistant Professor, Coventry UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2120982023-08-27T22:42:36Z2023-08-27T22:42:36ZFinancial education has its limits – if we want New Zealanders to be better with money, we need to start at home<p>Even as an economics student at university, I remember heading into town on a Friday night knowing what I needed to pay the bills before I could spend on socialising. But despite having the financial literacy to know better, Monday could still sometimes begin with a trip to the bank to ask for an overdraft extension. </p>
<p>So it was encouraging to hear that financial education has become a political talking point ahead of this year’s election. Both <a href="https://www.stuff.co.nz/national/politics/132778326/labour-promises-compulsory-financial-literacy-lessons-for-school-children-national-backs-the-idea">Labour</a> and <a href="https://www.1news.co.nz/2023/08/20/national-also-aiming-to-make-financial-literacy-compulsory-in-schools/">National</a> are promising to deliver compulsory financial literacy classes as part of the school curriculum. </p>
<p>Labour’s proposed financial literacy programme would include the basics of budgeting, financial concepts and how to be good with money. It would also include explanations of interest rates, retirement savings, insurance, debt and borrowing. </p>
<p>And when Prime Minister Chris Hipkins said “it shouldn’t matter what circumstances you were born into, you should still be able to learn concepts to help you”, he was right. Improved financial literacy can only be a good thing for New Zealand. </p>
<p>With the country in a recession, New Zealanders are facing both <a href="https://theconversation.com/dont-let-financial-shame-be-your-ruin-open-conversations-can-help-ease-the-burden-of-personal-debt-202496">ballooning debt and a legacy of poor saving</a>. The average household debt in New Zealand is now more than 170% of gross household income. This is higher than the United Kingdom (133%), Australia (113%) or Ireland (96%). </p>
<p>And yet, researchers remain divided over whether financial education can actually have a positive impact on financial behaviour in the long term. In New Zealand and elsewhere, it seems factors closer to home have a greater influence on a person’s financial literacy than anything learned at school. </p>
<h2>Education, borrowing and debt</h2>
<p>One 2014 <a href="https://openknowledge.worldbank.org/entities/publication/44870ac3-5b7e-57f7-be49-000f56f4cc30">meta-analysis</a> of 188 research papers and articles concluded financial literacy interventions had a positive impact on increasing savings, but had no impact on reducing loan defaults. </p>
<p>A <a href="https://openknowledge.worldbank.org/entities/publication/eb8b7699-0d2f-5d6d-ab1e-4262122c1a9c">second analysis of 126 studies</a>, published in 2017, found financial education positively affected financial behaviour – but this had limits for lower-income families. Much like the earlier study, the researchers found borrowing behaviour was more difficult to change with formal education than saving behaviour. </p>
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Read more:
<a href="https://theconversation.com/are-you-financially-literate-here-are-7-signs-youre-on-the-right-track-202331">Are you financially literate? Here are 7 signs you're on the right track</a>
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<p>An important caveat is that these analyses measured the short-term response to hypothetical questions, not long-term behaviour.</p>
<p>But even when examining the impact of financial education on short-term behaviour, researchers found it was difficult to influence how people handled debt. Compulsory financial education did not improve the likelihood of getting into debt, or the likelihood of defaulting on loans. </p>
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<h2>Home and financial knowledge</h2>
<p>In his famous work on <a href="https://hr.berkeley.edu/how-social-learning-theory-works">social learning theory</a>, psychologist Albert Bandurra proposed that observation and modelling play a primary role in how and why people learn. They are particularly relevant to the development of financial attitudes, confidence and behaviour. </p>
<p>Specifically, young people learn from the financial behaviour <a href="http://abrn.asia/ojs/index.php/apjssr/article/view/61/68">modelled by their parents</a>, discussions about money in the home, and from receiving pocket money.</p>
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Read more:
<a href="https://theconversation.com/financial-literacy-is-a-public-policy-problem-84695">Financial literacy is a public policy problem</a>
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<p>It has been suggested the differences in how money and finances are dealt with in the home are linked to why women generally <a href="https://theconversation.com/hilda-survey-reveals-striking-gender-and-age-divide-in-financial-literacy-test-yourself-with-this-quiz-100451">score lower on financial literacy quizzes</a>, as do people from lower socio-economic backgrounds. </p>
<p>Parents’ education and their financial sophistication – whether they have stocks, for example – <a href="https://www.mdpi.com/1911-8074/16/4/252">have been shown</a> to affect their offspring’s financial literacy. Women are also found to have <a href="https://institute.eib.org/wp-content/uploads/2016/10/women-conf-lit.pdf">lower financial confidence</a>, even when they have the right knowledge.</p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"1504562088575918082"}"></div></p>
<p>In a <a href="https://www.emerald.com/insight/content/doi/10.1108/YC-07-2017-00717/full/html">New Zealand study</a> of over 1,200 young people aged 14 and 15, the age of the first financial discussion between parent and child was found to be an important influence on future financial knowledge, attitudes and intentions. </p>
<p>The study found boys, on average, had their first financial discussion in the home at a younger age than girls. The age at which these initial discussions happen influence a person’s financial literacy levels at tertiary education age and beyond, even accounting for other demographic variables. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/there-are-serious-problems-with-the-concept-of-financial-literacy-84836">There are serious problems with the concept of 'financial literacy'</a>
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<p>These findings suggest the way parents talk and manage finances in the home may be subject to a gender bias, contributing to <a href="https://onlinelibrary.wiley.com/doi/10.1111/ijcs.12179">different levels of financial literacy</a> – and confidence – between girls and boys. </p>
<p>So, as we consider adding financial education to New Zealand’s curriculum, it’s important to consider all of the factors that will feed into a student’s money literacy – and not just focus on test results in a classroom setting.</p><img src="https://counter.theconversation.com/content/212098/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen Agnew does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Both major political parties have promised to introduce financial literacy to New Zealand’s curriculum. But is school really the best place to teach students about money?Stephen Agnew, Senior Lecturer of Economics, University of CanterburyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2110682023-08-21T13:47:46Z2023-08-21T13:47:46ZHow rising interest rates are affecting UK businesses<figure><img src="https://images.theconversation.com/files/543717/original/file-20230821-23-2hink2.jpg?ixlib=rb-1.1.0&rect=0%2C33%2C7326%2C4858&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/worried-business-owner-working-his-shop-2199248649">Stock-Asso/Shutterstock</a></span></figcaption></figure><p>From <a href="https://www.theguardian.com/business/2023/aug/03/were-just-treading-water-uk-small-business-owner-higher-interest-rate-taking-their-toll?utm_term=64ccabd424ac776f6436d425fc8da30c&utm_campaign=BusinessToday&utm_source=esp&utm_medium=Email&CMP=bustoday_email">chip shops</a> to <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">tech start-ups</a>, and even large, <a href="https://www.standard.co.uk/news/uk/wilko-administration-high-street-retail-interest-rates-b1098476.html">well-established companies</a>, rising interest rates have had an impact right across the business world. After <a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">14 consecutive base rate hikes by the Bank of England</a> since 2021, this is causing particular problems for companies with a lot of debt. </p>
<p>We recently saw the chaos this can cause when English utility <a href="https://www.bbc.co.uk/news/business-66051555">Thames Water</a> nearly collapsed under the weight of its debt and had to seek emergency funding from its shareholders earlier this year. </p>
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<strong>
Read more:
<a href="https://theconversation.com/how-thames-water-came-to-be-flooded-with-debt-and-what-it-means-for-taxpayers-208788">How Thames Water came to be flooded with debt – and what it means for taxpayers</a>
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<p>More recently, budget retailer Wilko’s borrowing not only affected the business and its shareholders, but also its employees when its recent collapse put <a href="https://www.wionews.com/business-economy/uk-retailer-wilko-collapses-due-to-big-debts-12500-jobs-at-risk-624323">12,500 jobs at risk</a>.</p>
<p>Similar problems could arise among many other companies and industries. Financial markets expect the bank base rate – which dictates the rates on many types of loans – will keep climbing: it’s currently <a href="https://www.thetimes.co.uk/money-mentor/article/when-will-interest-rates-go-down-uk/">forecast to peak</a> between 5.75% and 6% by the start of 2024. And the <a href="https://www.statista.com/statistics/793368/value-of-business-corporate-loans-united-kingdom/">total value of UK business loans</a> is also expected to rise to an estimated £513 billion as of 2023. This is £78 billion higher than in 2018, an increase of 18%.</p>
<p>Company insolvencies have <a href="https://www.reuters.com/world/uk/england-wales-report-40-rise-company-insolvencies-2023-06-16/">already jumped by 40%</a> over the year to May 2023 in England and Wales – the highest level since monthly records began in January 2019. And significant debt problems within an industry or even one firm can cause a domino effect across the UK economy. </p>
<p>Research shows the effects of an insolvency or bankruptcy <a href="https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/spreading-the-misery-sources-of-bankruptcy-spillover-in-the-supply-chain/B87035D235D7AA2A443B5164C28EBA5B">can spread</a> to a firm’s trading partners. Wilko started to defer supplier payments and extend the timeframe in which it settles invoices <a href="https://www.retailgazette.co.uk/blog/2022/09/wilko-delays-supplier-payments/">last year</a> to try to ease pressure on its cash flow as it struggled to manage its debts.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/wilko-is-the-latest-shop-to-be-edged-out-by-competition-but-it-doesnt-have-to-mean-the-end-for-the-budget-retailer-211161">Wilko is the latest shop to be edged out by competition but it doesn't have to mean the end for the budget retailer</a>
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<p>So, with interest rates likely to continue to rise, being able to tell if another company or industry is at risk is important for customers, employees, investors and other connected businesses such as suppliers.</p>
<h2>The rising cost of business borrowing</h2>
<p>The average cost of new borrowing from banks by private non-financial companies was <a href="https://www.bankofengland.co.uk/statistics/money-and-credit/2023/june-2023">6.36% in June 2023</a>, more than 4 percentage points above the December 2021 rate of 2.03% (when the Bank of England base rate increases began). For small and medium-sized enterprise (SMEs), new loan rates increased from 6.86% in May to a record high of 7.13% in June (compared with 2.51% in December 2021). </p>
<p>Companies already holding debt that’s not on a fixed rate of interest could also see an increase in the interest owed to their lender. This could come as a shock since UK interest rates were <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">1% or less</a> for more than 13 years from February 2009 to June 2022. During this time, the pressure of debt on borrowers was light or negligible.</p>
<p><strong>The base rate has recently climbed from low levels</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the Bank of England base rate rising from less than 1% in 2020 to 5.25% by August 2023. by" src="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=345&fit=crop&dpr=1 600w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=345&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=345&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=433&fit=crop&dpr=1 754w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=433&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/543679/original/file-20230821-23-2cqa28.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=433&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The Bank of England base rate from January 2020 to August 2023.</span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates">The Bank of England</a></span>
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<p>Companies that got used to being able to borrow at a low cost are now starting to feel the pinch, or even come under extreme pressure if they are heavily indebted. This is what worsened the <a href="https://news.sky.com/story/thames-water-secures-additional-750m-from-shareholders-in-race-to-avoid-nationalisation-12918285">financial position of UK utility Thames Water</a>. When the company was privatised in 1989, it had no debt. But over the years it borrowed heavily to fund new investments. </p>
<p>Generally speaking, debt is a <a href="https://www.ofwat.gov.uk/thames-debt-and-water-sector-finance/">prudent low-cost source of finance</a> with low interest rates fixed for the long term. But Thames Water borrowed too much. It had <a href="https://www.bbc.co.uk/news/business-66051555">£14 billion in debt by the end of June 2023</a>, which amounted to 80% of the value of the business and made it the most heavily indebted of England and Wales’ water companies, according to analysts. Its loan repayments were not only linked to the bank base rate, but also inflation, which has also spiked over the past year. This triggered fears about the company’s ability to continue to service its debts.</p>
<p>Thames Water was lucky, in a sense – it avoided being nationalised because it was able to secure timely funding from its shareholders. But the situation revealed the extent of the iceberg under the water in this industry. Shortly afterwards, another English utility, Southern Water, announced <a href="https://www.reuters.com/world/uk/britains-southern-water-suspends-dividend-amid-growing-debt-pile-rating-2023-07-07/">it would not pay dividends</a> until at least 2025 after its credit rating was downgraded. This shows investors, lenders and credit ratings agencies are getting more nervous about debt-related trends within industries.</p>
<p>Businesses can help to ease such concerns by being transparent.
<a href="https://onlinelibrary.wiley.com/doi/full/10.1002/bse.3055">Research</a> shows that the more firms disclose financial and non-financial information, the more likely they are to be able to secure loans and access lower rates. This also applies to companies that are <a href="https://www.sciencedirect.com/science/article/abs/pii/S0167268117302263">more open with external partners</a> by sharing resources and knowledge to enhance innovation. The more information a bank has, the more comfortable it will be about lending to a company. It also reduces the bank’s own risk rating, allowing it to lend more and offer lower rates. </p>
<figure class="align-center ">
<img alt="Man in suit with blue tie holding three blocks showing bank symbol, rating symbol and chart symbol with arrow and percentage, with " src="https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/543720/original/file-20230821-15-ev2p8p.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Credit ratings influence how much and to which companies banks will lend.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/credit-rating-concept-finance-banking-investment-2248616763">Panchenko Vladimir/Shutterstock</a></span>
</figcaption>
</figure>
<h2>What to look out for in the current environment</h2>
<p>Business leaders that are addressing rising interest rates head-on may announce adjustments to their growth or expansion plans, especially if a plan previously relied heavily on debt. They may also consider different sources of finance. The UK water regulator, for example, has called on utilities to consider the role of equity funding (<a href="https://www.british-business-bank.co.uk/finance-hub/what-is-equity-finance/">for example, selling shares</a>) and <a href="https://www.ofwat.gov.uk/thames-debt-and-water-sector-finance/">not just debt</a> in financing new investment.</p>
<p>A company’s <a href="https://www.investopedia.com/terms/d/debtratio.asp#:%7E:text=The%20debt%20ratio%20is%20defined,that%20are%20financed%20by%20debt.">ratio of debt versus assets</a> will also tell you how much it holds in debt. A “good” debt ratio is around 1 to 1.5, but <a href="https://www.british-business-bank.co.uk/finance-hub/what-level-of-debt-is-healthy-for-business/">the ideal can vary</a> by industry. Manufacturers, for example, tend to need a lot of equipment and so may have ratios greater than 2.</p>
<p>More interest rate rises will pile pressure on companies, employees and the economy. But by anticipating the impact on their debt and being more open about their current state and future plans, businesses can help to minimise the pain.</p><img src="https://counter.theconversation.com/content/211068/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Erwei (David) Xiang does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Recent interest rate hikes are not just a problem for mortgage borrowers, many companies are suffering too.Erwei (David) Xiang, Senior Lecturer (Associate Professor) in Accounting, Newcastle UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2081902023-06-26T14:00:35Z2023-06-26T14:00:35ZAfrica needs its own credit rating agency: here’s how it could work<figure><img src="https://images.theconversation.com/files/533431/original/file-20230622-17-t2nl2v.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Credit ratings are important for developing economies in Africa</span> <span class="attribution"><span class="source">Wikimedia Commons</span></span></figcaption></figure><p>The credit rating industry in Africa is dominated by the three international agencies: <a href="https://www.moodys.com/">Moody’s</a>, <a href="https://www.spglobal.com/ratings/en/">S&P</a> and <a href="https://www.fitchratings.com/">Fitch</a>. Together they control an estimated 95% of the credit rating business globally. </p>
<p>Credit rating agencies are institutions that assess a borrower’s creditworthiness in general terms, or with respect to a particular debt or financial obligation. A credit rating can be assigned to any entity that seeks to borrow money – an individual, a corporation, a state or provincial authority, or a sovereign government. Investors use a credit rating to make decisions about risk and return. So the rating is required if an institution wants to raise funds on financial markets.</p>
<p>South Africa was the <a href="https://www.aprm-au.org/wp-content/uploads/2021/03/21-International-credit-rating-agencies-in-Africa-perceptions-trends-and-challenges.pdf">first African country</a> to receive a sovereign rating, in 1994. To date, <a href="https://www.aprm-au.org/wp-content/uploads/2021/03/21-International-credit-rating-agencies-in-Africa-perceptions-trends-and-challenges.pdf">32 African countries</a> have received a sovereign rating from at least one of the “big three” agencies. </p>
<p>But policy makers are increasingly <a href="https://au.int/en/pressreleases/20220208/aprm-denounces-moodys-inaccuracies-ghanas-rating-downgrade">dissatisfied</a> with their approach and methodology. Some of the criticisms are that agencies are <a href="https://myjoyonline.com/akufo-addo-takes-on-global-rating-agencies-describes-their-work-as-reckless">quick to downgrade African</a> countries but slow when upgrades are due; that they <a href="https://www.brookings.edu/wp-content/uploads/2021/10/21.10.07_Perception-premiums.pdf">fail to accurately account for risk perception</a>; that they don’t <a href="https://aprm.au.int/en/documents/2023-01-30/africa-sovereign-credit-rating-review-6th-edition">consult adequately with stakeholders</a>; and that they <a href="https://econpapers.repec.org/article/afjjourn4/v_3a7_3ay_3a2022_3ai_3a1_3ap_3a8-9.htm">lack independence and objectivity</a>. </p>
<p>A recent study by the <a href="https://www.undp.org/africa/publications/lowering-cost-borrowing-africa-role-sovereign-credit-ratings">UN</a> showed that subjective biases in credit ratings had cost African countries a <a href="https://www.undp.org/press-releases/more-objective-credit-ratings-could-save-billions-african-countries-development">combined US$74.5 billion</a>. This was through funding opportunities lost and excess interest paid on public debt.</p>
<p>Conditions are therefore ripe to advance the idea of establishing an African credit rating agency as a partial solution. <a href="https://financefeeds.com/chinas-new-credit-rating-agency/">China</a> has its own state-owned rating agency, Dagong Global Credit Rating Company. The Arab countries are also calling for their <a href="https://www.tradearabia.com/news/BANK_409480.html">own rating agency</a>.</p>
<p>As a <a href="https://www.linkedin.com/in/misheck-mutize-phd-68131a2a/?originalSubdomain=za">lead expert with the African Union</a> on ratings agencies, I can explain the framework this agency would operate in and why it makes business sense.</p>
<h2>African Union official decisions</h2>
<p>In March 2019, African Union (AU) ministers of finance and economy officially adopted <a href="https://au.int/en/documents/20190308/2019-stc-finance-monetary-affairs-economic-planning-and-integration">a declaration that such an institution was needed</a>. The AU also developed a proposal for the legal, financial and structural aspects of the rating agency. What’s not yet agreed is how the sustainability, credibility and independence of the agency will be achieved. But there is a way this could be achieved as I set out below.</p>
<p>The need for an African Rating agency has been <a href="https://www.africanews.com/2022/05/16/au-chair-wants-pan-african-financial-rating-agency//">reiterated</a> by the current Chair of the AU, President <a href="https://www.uneca.org/stories/eca%E2%80%99s-conference-of-ministers-%28com2022%29-kicks-off-in-dakar%2C-senegal">Macky Sall</a> of Senegal, and the Champion of the AU financial institutions, President <a href="https://au.int/en/pressreleases/20220720/ghana-supports-establishment-african-credit-rating-agency">Nana Akufo-Addo</a> of Ghana. They highlighted it as an important step towards intra-continental integration. It would also enable AU member states to access capital and integrate the continent with global financial markets.</p>
<h2>Institutional model</h2>
<p>When the AU establishes a new institution, it can be either:</p>
<ul>
<li><p>an organ of the union funded by its member states’ contributions, or</p></li>
<li><p>a self-funded autonomous specialised agency of the union. </p></li>
</ul>
<p>Because the credit rating business requires credibility and independence, the best option is the specialised agency. Examples already in operation are the <a href="https://www.afreximbank.com/">African Export-Import Bank</a> and <a href="https://www.arc.int/">Africa Risk Capacity</a> agency. </p>
<p>As an independent specialised agency of the AU, the agency would have diverse classes of shareholders. African governments could own it either directly or through their designated public institutions. Shareholding could include other smaller African-owned rating agencies, multilateral finance institutions and African national financial institutions.</p>
<p>As a financing structure, the agency would adopt the “issuer-pay” business model. The issuers of debt will pay the agency for rating its entity and products.</p>
<p>It would be fully funded by its shareholders and through loans from pan-African financial institutions. Multilateral development banks would either encourage or make it mandatory for their clients to have a rating from the African rating agency. Once this is done it should be able to sustain itself through revenue generated from its services. </p>
<p>As is the process in the AU, the African rating agency would be established through an agreement, signed by at least 10 member states. </p>
<h2>The business case</h2>
<p>There are still 22 African countries that have no credit ratings from the “big three” agencies. This will be a clear niche for the AU rating agency. </p>
<p>There is also tremendous value in the alternative rating sector, which cannot afford the cost of maintaining a rating from the “big three”. This includes small to medium enterprises, initial bond offerings and initial public offerings. The agency could also provide environmental, social and governance scores and foreign direct investment ratings. These rating services are urgently needed on the continent to complement governments’ efforts to support the development of domestic financial markets.</p>
<p>With the backing that comes from affiliation to the AU, the rating agency could secure substantial business in the ratings of domestic instruments that are aligned with the continent’s goals. </p>
<p>It would have the advantage of understanding the domestic context of Africa. So it could issue more informative and detailed ratings than those issued by the “big three”.</p>
<h2>Way forward</h2>
<p>The African Union is forging ahead with its plans to establish an African rating agency to complement the three dominant international agencies, and support the development of domestic financial markets in Africa. Although it will have to overcome challenges to gain investors’ support, there is a <a href="https://www.brookings.edu/wp-content/uploads/2016/07/04-foresight-capital-market-growth-songwe-1.pdf">huge appetite</a> for an alternative and complementary credit rating institution in Africa. Its success will be in developing a comprehensive methodology adapted to the African context, and resident analysts that understand the continent’s dynamics.</p><img src="https://counter.theconversation.com/content/208190/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Misheck Mutize is affiliated with the African Union as a Lead Expert on Credit Ratings</span></em></p>African states say a pan-African rating agency will enable them to access capital and integrate the continent with global financial markets.Misheck Mutize, Post Doctoral Researcher, Graduate School of Business (GSB), University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2082152023-06-22T16:04:33Z2023-06-22T16:04:33ZWhy the Bank of England’s interest rate hikes aren’t slowing inflation enough and what that means for mortgages<p>Consumer price inflation <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">stuck at 8.7%</a> in May, defying expectations of a slowdown and making a further rise in UK interest rates inevitable. </p>
<p>The May figures came out the day before the Bank of England’s Monetary Policy Committee (MPC) was due to meet to discuss changing the UK base rate. This sets the interest rates for borrowing by the government, businesses and banks – who then feed any increases through to borrowers such as people with mortgages.</p>
<p>A 13th consecutive rise in June had been expected for some time, because <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2023">the headline rate of inflation</a> has been well above its medium-term 2% target since mid-2021. At the risk of being accused of derailing the UK’s post-COVID economic recovery, MPC members’ main decision at the most recent meeting was not whether or not to hike rates, but by how much. </p>
<p>The latest <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/june-2023">0.5% increase (to 5%)</a> represents a jump from previous 0.25% increments, showing their concern that inflation is becoming embedded in the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/inflation-why-prices-look-likely-to-stay-high-in-the-uk-and-ireland-and-what-that-means-for-mortgages-207625">Inflation: why prices look likely to stay high in the UK and Ireland, and what that means for mortgages</a>
</strong>
</em>
</p>
<hr>
<p>By increasing rates, the central bank is engaging in “monetary tightening”, which is designed to reduce the level of demand for goods and services in the economy. Households are encouraged to pay down debts and channel more of their incomes into saving. Those who cannot reduce their borrowing must pay more for it, leaving less to spend on other things. </p>
<p>The knock-on effect of rate hikes on people’s mortgage costs could result in a <a href="https://www.theguardian.com/money/2023/jun/21/1-point-4m-uk-households-huge-hit-to-finances-mortgage-timebomb-payments-fifth-disposale-income">20% hit to the disposable incomes</a> of 1.4 million mortgage holders before the next election, according to the Institute of Fiscal Studies. The government also finds its own <a href="https://tradingeconomics.com/united-kingdom/government-bond-yield">debt costs going up</a>, curbing ministerial inclinations to spend more money. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-bonds-are-in-meltdown-again-what-does-that-mean-for-pensions-expert-qanda-206533">UK bonds are in meltdown again – what does that mean for pensions? Expert Q&A</a>
</strong>
</em>
</p>
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<p>And so, this policy has obvious social costs. As well as ruling out any government help with this latest cost of living shock, it punishes those who have been <a href="https://www.jrf.org.uk/report/dragged-down-debt-millions-low-income-households-pulled-under-arrears-while-living-costs-rise">forced to borrow due to poverty</a>, as well as the better-off who chose to borrow to accumulate more assets. It also has longer-term economic costs, <a href="https://www.bankofengland.co.uk/quarterly-bulletin/2021/2021-q2/influences-on-investment-by-uk-businesses-evidence-from-the-decision-maker-panel">deterring firms from borrowing for investment</a>. </p>
<p>But the MPC believes it has no alternative. Although volatile items, especially food, can be blamed for some of the current overshoot, core inflation (which removes these fluctuating items) has risen to a <a href="https://tradingeconomics.com/united-kingdom/core-inflation-rate">31-year high of 7.1%</a>. </p>
<p>For monetary policymakers, the fear is that, if they don’t act decisively now, inflation will become built into firms’ expectations when setting prices, as well as those of employees bargaining over wages. Such self-fulfilling expectations are blamed by many for a “<a href="https://ukandeu.ac.uk/stagflation-the-return-of-an-unwelcome-monster/">wage-price spiral</a>” that created a decade-long period of inflation and stagnation in the UK following the <a href="https://obr.uk/box/the-changing-impact-of-fossil-fuel-shocks-on-the-uk-economy/">oil price shocks of 1973</a>. </p>
<p>The number of rate increases since 2021 reflects an unexpected slowness for these hikes to take effect on inflation. Although a painfully blunt instrument in this respect, interest rates are the only one the MPC has. </p>
<h2>A convenient scapegoat</h2>
<p>The government has <a href="https://news.sky.com/story/cost-of-living-on-me-personally-if-inflation-isnt-halved-says-rishi-sunak-12898285">pledged to halve inflation</a> by year-end and is now in danger of breaking this promise. It’s convenient, then, to allow the <a href="https://www.telegraph.co.uk/business/2023/06/21/recession-inevitable-bank-of-england-lost-control-inflation/">blame for overshooting inflation</a> to be placed on the independent central bank. </p>
<p>With hindsight, the Bank of England’s <a href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates#:%7E:text=That%20includes%20the%20lending%20and,Bank%20Rate%20is%20currently%204.5%25.">policy since the 2008 global financial crisis</a> is easy to criticise. It kept interest rates close to zero from February 2009 to March 2020, reducing them further during the COVID pandemic, then lifting them rapidly since December 2021. </p>
<p><strong>Base rate changes: 2006-2023</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the base rate at nearly 6% in 2008 before dropping below 1% until 2021 when it started rising again to reach 4.5% in May 2023." src="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=345&fit=crop&dpr=1 600w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=345&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=345&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=433&fit=crop&dpr=1 754w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=433&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=433&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The Bank of England base rate, 2006-2023.</span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates#:~:text=That%20includes%20the%20lending%20and,Bank%20Rate%20is%20currently%204.5%25.">Bank of England</a></span>
</figcaption>
</figure>
<p>The long phase of ultra-low interest rates deterred households and firms from paying down the debts that underlay the 2008 crisis. So the unprecedented jump in interest rates since 2021 has caused a sudden shock to corporate and household cashflows. Even now, many mortgage borrowers are <a href="https://www.mirror.co.uk/money/martin-lewis-says-mortgage-timebomb-30282073">still waiting to feel the full force</a>. </p>
<p>When this does happen, the rise in borrowing costs – on top of the surge in other living costs – could tip an already slow-growing economy back into full-blown recession. That would be compounded if, as in the <a href="https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/1995/the-housing-market-and-the-economy.pdf">early 1990s</a>, falling house prices knock a further hole in the finances of UK homeowners. </p>
<p>But it could also be argued that the post-2008 decade of low interest rates was unavoidable. Governments and business needed to borrow at low cost to haul the economy out of the deep 2009-2010 recession. During this time, inflation was close to zero and any lasting fall in consumer prices could have created a further slump. </p>
<p>The sharp interest-rate rise since 2021 has been equally unavoidable. As well as restraining inflation, it is needed to attract foreign investment to finance the UK’s <a href="https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/bulletins/balanceofpayments/octobertodecember2022">persistent current-account deficits</a>. </p>
<p>These used to be comfortably financed by foreign direct investment (FDI), which offset the UK’s excess of imports over exports. But FDI has <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-8534/">tailed downwards</a> since the 2016 Brexit vote. </p>
<p>So external financing now relies more heavily on foreign financial investors, who are looking for a higher return – as is evident from the rising yield the government must pay on its <a href="https://www.ft.com/content/04b15997-c4a3-4ad1-9244-db0fbb68b537">own borrowing</a>. </p>
<figure class="align-center ">
<img alt="A long exposure capturing the traffic trails at a busy junction at night." src="https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=338&fit=crop&dpr=1 600w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=338&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=338&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England building (left) in the City of London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/long-exposure-capturing-traffic-trails-busy-2186057577">Jason Wells/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Treatment-resistant inflation</h2>
<p>Although inevitable, the recent succession of interest rate rises has done little to tame the inflation we’re all experiencing at the moment. </p>
<p>Since early 2022, most prices have been pushed up by rising costs, which is known as <a href="https://www.investopedia.com/terms/c/costpushinflation.asp">cost-push inflation</a>. Raw material costs have been fuelled by the global rise in food and energy prices, and last autumn’s steep <a href="https://www.goldmansachs.com/intelligence/pages/why-the-british-pound-fell-to-a-record-low-against-the-us-dollar.html">depreciation of the pound against the US dollar</a>. Rising wage costs are an inevitable result of widespread labour shortages, exacerbated in the UK by a <a href="https://obr.uk/box/the-impact-of-the-pandemic-on-labour-market-participation/">post-COVID fall in workforce numbers</a> and the <a href="https://www.ecb.europa.eu/pub/economic-bulletin/articles/2023/html/ecb.ebart202303_01%7E3af23c5f5a.en.html">loss of EU workers</a> since Brexit.</p>
<p>With the government’s own borrowing costs climbing back towards the level that triggered fiscal meltdown after <a href="https://www.niesr.ac.uk/wp-content/uploads/2022/12/NIESR-Term-Premia-Tracker-Dec-2022.pdf">last September’s Truss budget</a>, it now risks a further <a href="https://www.santander.com/en/stories/what-is-stagflation#:%7E:text=%E2%80%9CStagflation%E2%80%9D%20is%20a%20combination%20of,less%20bang%20for%20your%20buck.">stagflationary spiral</a> – a combination of high inflation and an economy in recession. Rising interest rates are likely to divert more budget spending from growth-promoting projects into servicing public debt.</p>
<p>But if mortgage borrowers get any short-term relief from rising rates, it will only be in the <a href="https://www.reuters.com/world/uk/uks-hunt-says-mortgage-holders-should-not-expect-financial-help-2023-06-20/">unlikely event</a> that the shock from the <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/june-2023">latest rate rise</a> to 5% prompts emergency action to avert a pre-election recession.</p><img src="https://counter.theconversation.com/content/208215/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Interest rate hikes are the Bank of England’s main monetary policy weapon against inflation, but they aren’t working.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2053362023-05-17T10:46:24Z2023-05-17T10:46:24ZMortgage lenders are relaxing their rules – here’s why that could be risky for borrowers<figure><img src="https://images.theconversation.com/files/526553/original/file-20230516-17-melcmo.jpg?ixlib=rb-1.1.0&rect=137%2C47%2C3856%2C2443&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Budgeting to buy a home.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/buying-selling-houses-real-estate-prices-1032268546">Tero Vesalainen/Shutterstock</a></span></figcaption></figure><p>The Bank of England increased its base rate yet again in May 2023 to 4.5%, pushing borrowing costs to the <a href="https://theconversation.com/bank-of-england-interest-rate-rise-why-this-could-be-the-last-increase-for-a-while-205337">highest level in almost 15 years</a>. More than <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">6 million UK households</a> will now see their mortgage payments increase by the end of 2025, with more than <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">4 million</a> experiencing this in 2023.</p>
<p>For an average household this would mean an increase from <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">£750 to £1,000 in monthly payments</a> – or around 17% of average pre-tax income compared to 12% in June 2022. As the pressure of increasing interest costs, as well as rising house prices, weighs on households, mortgage lenders are developing and offering borrowers different kinds of products in response. </p>
<p>UK lender Skipton Building Society <a href="https://www.skipton.co.uk/press-office/press-release-article?BlogID=%7B13A47958-66DB-4D1A-B686-F7BFCF3FD742%7D">recently launched a 100% or no-deposit mortgage</a> as “a lifeline to tenants across the country, to help them break out of their trapped rental cycles and onto the property ladder for the first time”. Alternatively, <a href="https://www.ftadviser.com/mortgages/2019/06/26/most-mortgages-now-have-40-year-terms/?utm_campaign=FTAdviser+news&utm_source=emailCampaign&utm_medium=email&utm_content=">home loans that last as long as 40 years</a> – so-called <a href="https://www.thisismoney.co.uk/money/mortgageshome/article-12079901/63-000-thats-extra-cost-150-000-marathon-mortgage.html">marathon mortgages</a> – are on the rise. They can make it easier for some people to get on the property ladder by stretching out payments over a longer period.</p>
<p>But mortgage lending criteria were <a href="https://www.tandfonline.com/doi/full/10.1080/14616718.2011.548585?scroll=top&needAccess=true&role=tab&aria-labelledby=full-article">tightened for good reason after the 2008 global financial crisis</a>. And while these recent relaxations may be designed to help struggling would-be borrowers trapped in rising interest rate, rent and house price hell, hopeful homeowners should be very cautious about the risks involved.</p>
<h2>Long-term loans</h2>
<p>Prior to 2007, mortgage terms were rarely longer than 25 years. Only about 21% of first-time borrowers and 8% of remortgages opted for such a long term in December 2007. While <a href="https://www.zoopla.co.uk/discover/property-news/uk-lender-offers-40-year-fixed-rate-mortgage/">one lender</a> started offering a 40-year fixed rate product at the end of 2021, marathon mortgages are long-term loans but don’t typically offer a fixed rate for the length of the loan. By 2022 more than 55% of first-time borrowers and 34% of remortgagers had <a href="https://www.ukfinance.org.uk/system/files/2023-03/Household%20Finance%20Review%202022%20Q4.pdf">home loans with terms of more than 30 years</a>.</p>
<p><strong>Mortgage terms are getting longer</strong></p>
<p>This recent resurgence is most likely due to the affordability benefits of marathon mortgages. <a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">Extending the term of a loan allows borrowers</a> to stretch out the repayment costs of a mortgage over time. It also allows people to purchase a more expensive home – an important benefit in today’s market where average house prices have rocketed from £190,000 in 2009 to just shy of £300,000 in 2023.</p>
<p><strong>House prices have been rising</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing rising UK average house prices since 2005." src="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=339&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=339&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=339&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=427&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=427&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=427&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/previousReleases">Office for National Statistics UK House Price Index</a></span>
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</figure>
<p>Long-term mortgages also help borrowers qualify for mortgages under the <a href="https://www.fca.org.uk/news/press-releases/new-mortgage-rules-come-force">stricter affordability rules</a> introduced by the UK’s financial regulator in 2014. These rules require lenders to ensure that borrowers have sufficient monthly income to cover living expenses and other debts after their mortgage payments. </p>
<p>Spreading the cost to around 40 years allows marathon mortgage holders to reduce monthly costs, passing affordability assessments. Marathon mortgages do not seem to be a current concern for the regulator.</p>
<p>Of course, a marathon mortgage borrower could shorten their term over the years as they remortgage to avoid the lender’s standard variable rate. Also, if the base rate decreases over time, interest payments will fall and the overall mortgage will become more affordable. And, of course, any future increase in income allows a borrower to overpay during the term of the loan.</p>
<p>On the the other hand, long-term borrowing means significantly higher interest payments. For example, <a href="https://www.moneysavingexpert.com/mortgages/mortgage-rate-calculator/">a household borrowing £250,000 at a rate of 5% for 25 years</a> would pay a total of £188,600 in interest over the lifetime of the mortgage (assuming, for simplicity, that the interest rate does not change over the life of the mortgage). But borrowing for 40 years would result in total interest payments of £328,930 – a staggering £140,330 difference.</p>
<p>Marathon mortgages may also mean borrowers must make repayments <a href="https://www.ukfinance.org.uk/system/files/2023-03/Household%20Finance%20Review%202022%20Q4.pdf">well into their 70s</a> considering the <a href="https://www.money.co.uk/mortgages/first-time-buyer-mortgages/statistics">average age for first-time buyers outside London is now around 33</a>. For some this may mean continuing to pay a mortgage into retirement. This should be a key consideration when considering long-term borrowing. It would certainly impact financial security after retirement so careful planning and independent financial advice is crucial.</p>
<figure class="align-center ">
<img alt="Hands cupped underneath chart showing rising house values." src="https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/rising-house-sales-concept-742144642">Sasun Bughdaryan/Shutterstock</a></span>
</figcaption>
</figure>
<h2>No-deposit mortgages</h2>
<p>Rising rents, coupled with <a href="https://www.ft.com/content/0ebcf348-a664-442c-9311-5443e2d80f53">soaring prices of other essential expenses</a> such as food and energy bills, have left many first-time buyers struggling to save for a deposit. No-deposit products help first-time buyers break this cycle by swapping rental costs with mortgage payments, allowing them to eventually own their home. </p>
<p>Skipton Building Society’s recent launch of a <a href="https://www.skipton.co.uk/mortgages/track-record-mortgage">“100% mortgage”, which means borrowers don’t need a deposit</a>, aims to help first-time buyers of homes of up to £600,000 get onto the property ladder. </p>
<p>Such products were commonly available before the 2008 financial crisis. But the sharp fall in house prices since – mainly the 20% drop between 2007 and 2009 – <a href="https://www.ft.com/content/f067f31e-56c8-11de-9a1c-00144feabdc0">is reported to have left around a million households stuck in negative equity</a>. This is when your home is worth less than the mortgage you owe on it, leaving you unable to sell your properties.</p>
<p>The danger now is that the average house price today is much higher than the pre-financial crisis period (£300,000 versus £190,000). So, if such price drop were to happen in the near future, the impact would be even more devastating for no-deposit mortgagers. Although a crash does not seem to be on the cards, <a href="https://www.halifax.co.uk/assets/pdf/april-2023-house-price-index.pdf">downward pressure on house prices is expected</a>. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-house-prices-history-says-the-market-is-in-for-a-long-slowdown-not-a-crash-186072">UK house prices: history says the market is in for a long slowdown not a crash</a>
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<p>As we experienced in the aftermath of the 2008 financial crisis, relaxed lending criteria combined with borrowing beyond means can have dire consequences. It’s important for borrowers to be aware of these risks and to be very cautious when thinking about borrowing for the long term, particularly without a deposit.</p><img src="https://counter.theconversation.com/content/205336/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>New mortgage products designed to help struggling first-time buyers hark back to the pre-2008 market and so should come with a warning.Alper Kara, Professor and Head of Department - Accounting, Finance and Economics, University of HuddersfieldLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2048632023-05-02T17:23:54Z2023-05-02T17:23:54ZYellen puts Congress on notice over impending debt default date: 5 essential reads on what’s at stake<figure><img src="https://images.theconversation.com/files/523872/original/file-20230502-28-3tukkp.jpg?ixlib=rb-1.1.0&rect=12%2C38%2C4230%2C2723&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Treasury Secretary Janet Yellen doesn't want to look back in anger over a debt deadline missed.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/secretary-janet-yellen-leaves-after-an-open-session-of-a-news-photo/1483917268?adppopup=true">Photo by Alex Wong/Getty Images</a></span></figcaption></figure><p>Lawmakers have been <a href="https://apnews.com/article/x-date-debt-ceiling-yellen-treasury-borrowing-f726fd88a9bb7f72e50f0b948731ac57">given notice of a new deadline</a> if they are to avoid a damaging default on U.S. debt: June 1, 2023.</p>
<p>If Congress fails to raise the nation’s borrowing limit by that date, <a href="https://home.treasury.gov/news/press-releases/jy1454">Treasury Secretary Janet Yellen warned</a>, then the federal government risks being “unable to continue to satisfy all of the government’s obligations.”</p>
<p>Giving herself a little wiggle room by saying that it is pretty hard to work out the exact date of default, Yellen was clear on the potential impact: “If Congress fails to increase the debt limit, it would cause severe hardship to American families, harm our global leadership position, and raise questions about our ability to defend our national security interests.”</p>
<p>Yikes!</p>
<p>The warning may spur leaders in Congress into action. House Speaker Kevin McCarthy <a href="https://apnews.com/article/speaker-kevin-mccarty-debt-ceiling-biden-1dd542c6c7acfc2287e68e6facae2be4">fired the starting pistol on negotiations</a> over the debt ceiling in April, laying out the criteria under which Republicans would accept an increase. But McCarthy’s proposals – which have since passed <a href="https://www.theguardian.com/us-news/2023/apr/26/us-house-debt-ceiling-bill-passed-kevin-mccarthy">a narrow vote in the House</a> – have been shot down by the Biden administration for <a href="https://theconversation.com/snap-work-requirements-dont-actually-get-more-people-working-but-they-do-drastically-limit-the-availability-of-food-aid-204257">having strings attached</a> that Democrats deemed unacceptable.</p>
<p>Explaining why the U.S. has a debt ceiling in the first place – and why it is a constant source of political wrangling – is a complicated matter. Here are five articles from The Conversation’s archive that provide some of the answers.</p>
<h2>1. What exactly is the debt ceiling?</h2>
<p>So, some basics. The debt ceiling was established by the U.S. Congress in 1917. It limits the total national debt by setting out a maximum amount that the government can borrow.</p>
<p>Steven Pressman, an <a href="https://ww4.newschool.edu/nssr/faculty/steven-pressman/">economist at The New School</a>, explained the original aim was “to let then-President Woodrow Wilson spend the money he deemed necessary to fight World War I without waiting for often-absent lawmakers to act. Congress, however, did not want to write the president a blank check, so it limited borrowing to US$11.5 billion and required legislation for any increase.”</p>
<p>Since then, the debt ceiling has <a href="https://theconversation.com/why-america-has-a-debt-ceiling-5-questions-answered-164977">been increased dozens of times</a>. It currently stands at $31.4 trillion – a figure already reached. As a result, the Treasury has taken “extraordinary measures” to enable it to keep borrowing without breaching the ceiling. Such measures, however, can only be temporary – meaning at one point Congress will have to act to lift the ceiling or default on its debt obligations, which <a href="https://www.nytimes.com/2023/04/18/business/debt-limit-wall-street.html">is expected to happen in July</a> or August.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/why-america-has-a-debt-ceiling-5-questions-answered-164977">Why America has a debt ceiling: 5 questions answered</a>
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</em>
</p>
<hr>
<h2>2. ‘Catastrophic’ consequences</h2>
<p>How bad could it be if the U.S. does default on its debt obligations? Well, <a href="https://theconversation.com/if-the-us-defaults-on-debt-expect-the-dollar-to-fall-and-with-it-americans-standard-of-living-169079">pretty bad</a>, according to Michael Humphries, <a href="https://tci.touro.edu/academics/faculty/">deputy chair of business administration at Touro University</a>, who wrote two articles on the consequences. </p>
<p>“The knock-on effect of the U.S. defaulting would be catastrophic. Investors such as pension funds and banks holding U.S. debt could fail. Tens of millions of Americans and thousands of companies that depend on government support could suffer. The dollar’s value could collapse, and the U.S. economy would most likely sink back into recession,” he wrote.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/if-the-us-defaults-on-debt-expect-the-dollar-to-fall-and-with-it-americans-standard-of-living-169079">If the US defaults on debt, expect the dollar to fall – and with it, Americans' standard of living</a>
</strong>
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<hr>
<h2>3. Undermining the dollar</h2>
<p>And that’s not all. </p>
<p>Such a default could undermine the U.S. dollar’s position as a “unit of account,” which makes it a widely used currency in global finance and trade. Loss of this status would be a <a href="https://theconversation.com/us-debt-default-could-trigger-dollars-collapse-and-severely-erode-americas-political-and-economic-might-198395">severe economic and political blow</a> to the U.S. But Humphries conceded that putting a dollar value on the price of a default is hard: </p>
<p>“The truth is, we really don’t know what will happen or how bad it will get. The scale of the damage caused by a U.S. default is hard to calculate in advance because it has never happened before.”</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/us-debt-default-could-trigger-dollars-collapse-and-severely-erode-americas-political-and-economic-might-198395">US debt default could trigger dollar’s collapse – and severely erode America’s political and economic might</a>
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</em>
</p>
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<h2>4. Can McCarthy make a deal?</h2>
<p>Many of these concessions are known, such as allowing a single member of the House to call for a vote to remove him as speaker. But there many be others that remain secret and <a href="https://theconversation.com/house-speaker-mccarthys-powers-are-still-strong-but-hell-be-fighting-against-new-rules-that-could-prevent-anything-from-getting-done-197391">could be influencing McCarthy’s decision-making</a>, argued <a href="https://pennstatelaw.psu.edu/faculty/brand">Stanley M. Brand</a>, a law professor at Penn State and former general counsel for the House. These could make it much harder to reach a deal with Biden over the debt ceiling.</p>
<p>“Some of the new rules spawned by McCarthy’s concessions may appear to democratize the procedures for considering and passing legislation. But they are likely to make it difficult for members to get the working majority necessary to pass legislation,” Brand explained. “That could make things such as raising the statutory debt ceiling, which is necessary to avert a government shutdown and financial crisis, and passing legislation to fund the government, difficult.”</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/house-speaker-mccarthys-powers-are-still-strong-but-hell-be-fighting-against-new-rules-that-could-prevent-anything-from-getting-done-197391">House Speaker McCarthy's powers are still strong – but he'll be fighting against new rules that could prevent anything from getting done</a>
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</em>
</p>
<hr>
<h2>5. The GOP endgame: A balanced budget</h2>
<p>Another condition McCarthy agreed to in January is to push for a “balanced budget” within 10 years.</p>
<p>The U.S. government hasn’t had a balanced budget since 2001, the year President Bill Clinton left office. <a href="https://www.hks.harvard.edu/faculty/linda-bilmes">Linda J. Bilmes</a>, a senior lecturer in public policy and public finance at Harvard Kennedy School who worked in the Clinton administration from 1997 to 2001, explained how they achieved that rare feat and <a href="https://theconversation.com/i-helped-balance-the-federal-budget-in-the-1990s-heres-just-how-hard-it-will-be-for-the-gop-to-achieve-that-same-rare-feat-198363">why it’s unlikely to be repeated today</a>. </p>
<p>“Back in 1997, after the smoke cleared, both the Clinton administration and the Republicans in Congress were able to claim some political credit for the resulting budget surpluses,” she wrote. “But – crucially – both parties recognized that a deal was in the best interest of the country and were able to line up their respective members to get the votes in Congress needed to approve it. The contrast with the current political landscape is stark.”</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/i-helped-balance-the-federal-budget-in-the-1990s-heres-just-how-hard-it-will-be-for-the-gop-to-achieve-that-same-rare-feat-198363">I helped balance the federal budget in the 1990s – here's just how hard it will be for the GOP to achieve that same rare feat</a>
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<hr>
<p><em>Editor’s note: This story is a roundup of articles from The Conversation’s archives. Sections of this article appeared in a <a href="https://theconversation.com/speaker-mccarthy-lays-out-initial-cards-in-debt-ceiling-debate-5-essential-reads-on-why-its-a-high-stakes-game-204079">previous article</a> published on April 19, 2023.</em></p><img src="https://counter.theconversation.com/content/204863/count.gif" alt="The Conversation" width="1" height="1" />
If the US fails to increase its debt ceiling by June 1, it could be forced into an embarrassing – and hugely costly – default on its obligations.Matt Williams, Senior International EditorLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2014402023-04-05T14:51:43Z2023-04-05T14:51:43ZWhy you should care about bumper bank profits<figure><img src="https://images.theconversation.com/files/514942/original/file-20230313-14-7boqyc.jpg?ixlib=rb-1.1.0&rect=162%2C147%2C4610%2C2958&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/big-data-graph-virtual-screen-2023-2172883679">khunkornStudio/Shutterstock</a></span></figcaption></figure><p>The Bank of England has raised interest rates 11 times since December 2021 but, while this may boost bank profits, it is less likely to boost many people’s bank balances.</p>
<p>Alongside the sharp spike in interest rates over the past year, many big names in the UK banking business have been reporting bumper 2022 profits. NatWest made <a href="https://investors.natwestgroup.com/%7E/media/Files/R/RBS-IR-V2/results-center/17022023/nwg-announcement.pdf">£5.1 billion in 2022</a> before tax, up 33% and the highest since the 2008 global financial crisis. Fellow high street bank <a href="https://positivemoney.org/2023/02/29885/">Lloyds</a> made <a href="https://www.lloydsbankinggroup.com/assets/pdfs/investors/financial-performance/lloyds-banking-group-plc/2022/full-year/2022-lbg-annual-report.pdf">nearly £7 billion before taxes in 2022</a>.</p>
<p>Much like the energy companies that have experienced <a href="https://theconversation.com/why-energy-companies-are-making-so-much-profit-despite-uk-windfall-taxes-199523">huge increases in profits</a> as gas and electricity prices soared over the past year, the same is now happening at <a href="https://www.cityam.com/uk-banks-set-to-report-record-profits-of-37bn-beating-pre-financial-crisis-highs/">the UK’s large retail banks</a> as Bank of England interest rates have done the same. </p>
<p>These increases have little to do with CEO performance (although top executives took home <a href="https://committees.parliament.uk/committee/158/treasury-committee/news/186434/treasury-committee-questions-uks-largest-banks-on-savings-rates-and-ceo-pay/#:%7E:text=Several%20banks%20have%20also%20increased,rise%20in%20his%20pay%20package">significant pay packets for 2022</a>) or increases in efficiency within these banks. But they have everything to do with how retail banks make their money and the domination of the market by several key players. </p>
<p>Retail banking income has two main sources: interest income from lending or fee income from non-interest business (and sometimes a little trading income). Retail banks also earn interest on <a href="https://www.bankofengland.co.uk/bank-overground/2023/what-do-we-know-about-the-demand-for-bank-of-england-reserves">the billions they hold in reserves</a> with the Bank of England – this income has of course increased recently as the central bank has hiked its main rate.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">Interest rates: why your mortgage payments are going up but your savings aren't – and how better monetary policy could help</a>
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<hr>
<p>In the past 12 months there has been quite a steep rise in interest income, in particular net interest income. This is the amount banks pay out in interest (to savers, for example) versus the amount they make in interest from lending. So, for example, during 2022 NatWest Banking Group achieved a 30.6% increase in net interest income and Lloyds Banking Group an increase of nearly 50%. </p>
<p><strong>Growth in net interest income</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing two lines rising to depict annual growth of Net Interest Income at Lloyds Banking Group and NatWest Banking Group 2019-2022" src="https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=443&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=443&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=443&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=557&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=557&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514832/original/file-20230312-4945-xhq14p.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=557&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Year-on-year growth of net interest income at Lloyds Banking Group and NatWest Banking Group (2019-2022)</span>
<span class="attribution"><span class="source">Capital IQ, Annual Reports</span>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>There is some history behind these recent profits. In the mid-1980s, the “<a href="https://www.investopedia.com/terms/b/bigbang.asp">big bang</a>” began the deregulation of banking in the UK. This led to a change in the traditional banking business model towards riskier activities. </p>
<p>Rather than making money from getting and holding on to deposits and loans (a strategy known as “<a href="https://link.springer.com/chapter/10.1057/9780230103245_5">originate and hold</a>”) banks started to package up their loans and sell them on to further boost their profits (“<a href="https://link.springer.com/chapter/10.1057/9780230103245_5">originate to distribute</a>”). The resulting rise in this business and the focus on non-interest income such as fees for non-traditional business ultimately led to the largest financial crisis the world has ever seen.</p>
<h2>A new era in banking</h2>
<p>Since the 2008 global financial crisis, some retail banks have retrenched into older-style banking. NatWest, for example, now makes over 60% of its revenue from deposits and lending, for Lloyds this figure is about 70%. But others, including HSBC and Barclays, have continued to make over 60% of their total revenue from non-interest income sources, according to their latest financial reports.</p>
<p>The latter strategy makes sense in the very low interest rate environment that the UK was in up until 2022. When the central bank base rate is low, there is little money to be made from lending and holding deposits so banks can <a href="https://www.bis.org/publ/work807.pdf">make more money from non-interest income</a>. But when interest rates start to rise, the big winners are those focused on the deposit and lending markets.</p>
<p>This is because even though the Bank of England raises the bank rate to <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">influence other interest rates</a>, large retail banks get to choose when they feed these rate changes on to savers and borrowers.</p>
<p>Loans make up <a href="https://investors.natwestgroup.com/%7E/media/Files/R/RBS-IR-V2/results-center/17022023/nwg-annual-report-and-accounts.pdf">70% or more</a> of total assets at <a href="https://www.lloydsbankinggroup.com/assets/pdfs/investors/financial-performance/lloyds-banking-group-plc/2022/full-year/2022-lbg-annual-report.pdf">some high street banks</a>. This alone helps to boost revenues when rates rise. Many banks also charge a much higher rate on lending than they pay out for retail deposits and have been criticised in recent months for <a href="https://news.sky.com/story/banks-not-passing-on-higher-interest-rates-to-savers-mean-customers-miss-out-on-23bn-12829682#:%7E:text=Banks%20are%20under%20no%20obligation,shop%20around%20for%20better%20deals.&text=However%2C%20that%20hasn't%20stopped,response%20to%20soaring%20bank%20profits.">failing to pass on savings rate increases</a> as quickly as they’ve boosted mortgage costs.</p>
<p>This means that, at the same time banks are seeing increases in their interest income from loans (and their reserves at the Bank of England), the amount they are paying out in interest to depositors in some accounts can remain the same for a longer period – sometimes at 0%. Shockingly, the Bank of England estimates that UK households have a massive £265 billion sitting in non-interest-bearing deposits, up from £118 billion a decade ago.</p>
<p><strong>UK household savings not earning interest (£ millions)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing UK household savings rising from £118 billion in 2013 to £265 billion in 2023." src="https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=205&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=205&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=205&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=258&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=258&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514936/original/file-20230313-166-s5gtyy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=258&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/boeapps/database/fromshowcolumns.asp?Travel=NIxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2013&TD=13&TM=Mar&TY=2023&FNY=&CSVF=TT&html.x=81&html.y=35&C=ELU&Filter=N">Bank of England</a></span>
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</figure>
<p>Even then, <a href="https://www.tandfonline.com/doi/abs/10.1080/02692170802496695?journalCode=cira20">research suggests</a> retail banks tend to be much slower at increasing deposit rates than lending rates. Policymakers seem to have noticed this as the CEOs from four major UK retail banks – Barclays, NatWest, Lloyds and HSBC – were called to appear at a <a href="https://committees.parliament.uk/oralevidence/12667/pdf/">Treasury Committee hearing in February 2023</a> to discuss rapid increases in loan and mortgage rates versus limited rate rises for savers and depositors, among other issues.</p>
<p>“Customer choice” was cited as the main reason for the difference. All of the CEOs pointed out recent increases in rates on some savings products. However, research shows <a href="https://www.retailbankerinternational.com/analysis/7-day-current-account-switching-pay-uk-statistics-jan-2023/">savers often don’t switch</a> into these higher-paying accounts, people simply do not manage their deposits in such a dynamic way.</p>
<p>Since large retail banks <a href="http://fingfx.thomsonreuters.com/gfx/editorcharts/VIRGIN%20MONEY-M-A-CYBG/0H0012Y5G10G/index.html">dominate the deposit and lending market</a> in the UK, they are unlikely to change this aspect of their operations on their own. Some kind of regulation could help to force banks to pass on rate rises more quickly, of course. Introducing a windfall tax could also help. </p>
<p>But both of these solutions seem unlikely to happen in light of the government’s <a href="https://theconversation.com/banking-reforms-expert-qanda-will-relaxing-the-rules-help-the-uk-economy-and-what-are-the-risks-196312">recent banking reforms</a> and <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">the collapse of Silicon Valley Bank</a> (although this was not linked to net interest income). The fear of another banking collapse, alongside the new reforms, will only reinforce the perceived importance of bank profits and shareholders over consumers – even during a cost of living crisis.</p><img src="https://counter.theconversation.com/content/201440/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Webb does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The UK retail bank business model has allowed banks to make significant profits as interest rates have risen over the past year.Robert Webb, Professor of Banking & Applied Economics, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2007052023-02-28T00:00:03Z2023-02-28T00:00:03ZWhy a temporary flood levy on higher earners would be the fairest way to help pay for Cyclone Gabrielle<figure><img src="https://images.theconversation.com/files/512342/original/file-20230227-2222-radke0.jpg?ixlib=rb-1.1.0&rect=40%2C8%2C2955%2C2236&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Flooding in Hawke's Bay after Cyclone Gabrielle.</span> <span class="attribution"><span class="source">Getty Images</span></span></figcaption></figure><p>Cyclone Gabrielle’s trail of misery and destruction presents a major fiscal and political dilemma for the government: how should the country pay for the recovery? Does it borrow now and spread repayment over generations, or raise taxes in an election year?</p>
<p>Either way, the cost is significant. Finance Minister Grant Robertson has estimated the bill for fixing damaged or destroyed infrastructure at NZ$13 billion – equivalent to <a href="https://www.ird.govt.nz/about-us/tax-statistics/revenue-refunds/revenue-collected-2001-to-2022#:%7E:text=Taxes%2520on%2520individuals%2520up%2520198,the%2520year%2520to%2520June%25202022.">11.5% of tax revenue</a> collected in the year to June 2022.</p>
<p>According to Waka Kotahi, just repairing roads in the affected areas will <a href="https://www.nzherald.co.nz/nz/politics/cyclone-gabrielle-grant-robertson-hints-at-larger-budget-after-multi-billion-dollar-cyclone-cost/2AB6Y4OWEFB57APOPXWU74KXOM/">cost an estimated $1 billion</a> – more than a fifth of the agency’s usual annual expenditure. </p>
<p>On top of all this, New Zealand is still grappling with inflation and a cost-of-living crisis. The likely stimulus effect of significant government spending has to be part of the government’s calculations.</p>
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<h2>Between a rock and a hard place</h2>
<p>Reserve Bank governor <a href="https://www.politik.co.nz/orr-raise-taxes-or-i-will-raise-interest-rates/">Adrian Orr has already suggested</a> those in power will need to choose carefully between borrowing and raising taxes. The first option is predicted to stoke inflation. The second is politically challenging in an election year when the opposition is offering tax cuts.</p>
<p>Borrowing is undoubtedly the more politically attractive option for the government. The burden of repaying capital and interest could be spread over several years, perhaps over generations. (There are precedents for extreme debt spreading – some British government debt incurred in the 1750s was only <a href="https://www.gov.uk/government/news/repayment-of-26-billion-historical-debt-to-be-completed-by-government">repaid in 2015</a>.) </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/build-back-better-sounds-great-in-theory-but-does-the-government-really-know-what-it-means-in-practice-200514">'Build back better' sounds great in theory, but does the government really know what it means in practice?</a>
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<p>Borrowing money then spreading capital and interest costs over generations is a reasonable option for infrastructure projects, such as a dam that might be expected to last 100 years. </p>
<p>But the problem with borrowing to fix the damage caused by Cyclone Gabrielle is that we don’t know if, or when, another catastrophic weather event will occur. In fact, we seem to be experiencing so-called hundred-year storms with increasing frequency.</p>
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<h2>The burden of borrowing</h2>
<p>Adrian Orr has also cautioned that borrowing is likely to increase inflationary pressures. If that happens, we can expect the Reserve Bank to move the official cash rate higher sooner, prompting retail banks to raise interest rates. </p>
<p>This will cause further pain for owners of mortgaged properties and businesses with high levels of borrowing. The economy could move into a deep recession as a result. There is a risk, too, of the economic nightmare of stagflation (recession and inflation, last seen in the 1970s) reappearing.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/cyclone-gabrielle-hit-nzs-main-fruit-growing-region-hard-now-orchardists-face-critical-climate-choices-200252">Cyclone Gabrielle hit NZ's main fruit-growing region hard -- now orchardists face critical climate choices</a>
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<p>The government also needs to consider whether it’s fair to borrow to fix current problems. Younger generations already face the prospect of a bearing a disproportionate tax burden of funding the superannuation and health costs of older people. </p>
<p>And shifting an unpredictable climate-related debt burden between generations appears unfair. Even if global warming is restricted to 1.5°C from pre-industrial levels, it’s impossible to predict whether Gabrielle-type events will become the new normal, or what other climate change remediation future generations will have to fund.</p>
<h2>The trouble with tax</h2>
<p>While increasing taxes would not create the same financial problems as borrowing, it’s clearly less politically attractive in an election year. But if we were to assume the government might take this option, which taxes might be increased or introduced? </p>
<p>In the medium to long term, a shift to carbon taxation is needed, but that won’t solve the current fiscal problems. The rates base in cyclone-affected areas has been decimated, and there is no precedent for cross-subsidisation between local government authorities. </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/what-australia-learned-from-recent-devastating-floods-and-how-new-zealand-can-apply-those-lessons-now-200078">What Australia learned from recent devastating floods – and how New Zealand can apply those lessons now</a>
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<p>An increase on the goods and services tax (GST) might be anti-inflationary, but it would disproportionately affect lower-income groups. And a steep increase in fuel levies, while theoretically attractive, is politically implausible in an inflationary environment.</p>
<p>A punitive tax on forestry companies – a type of reverse windfall tax – might have some populist appeal, given the <a href="https://theconversation.com/cyclone-gabrielle-triggered-more-destructive-forestry-slash-nz-must-change-how-it-grows-trees-on-fragile-land-200059">role of slash</a> in cyclone damage. But this could lead to job losses in some of the poorest parts of the country. Besides, reform will be best achieved through fundamental changes to forestry practices rather than an ad hoc tax. </p>
<p>The introduction of entirely new taxes – such as a land tax, a comprehensive capital gains tax, or some form of wealth tax – would takes years to craft and implement. That leaves an income tax increase as the only plausible option.</p>
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<h2>A fairer flood levy</h2>
<p>Income tax surcharges are common during wartime. Countries like Germany and South Africa introduced temporary “solidarity” surcharges to fund national reconstruction or reunification (although the German <a href="https://www.bundesregierung.de/breg-en/solidarity-surcharge-469380#:%7E:text=The%20solidarity%20surcharge%20(Solidarit%C3%A4tszuschlag)%20is,surcharge%20is%20currently%205.5%20percent"><em>Solidaritätszuschlag</em></a> has still not been fully abolished).</p>
<p>But the most relevant precedent for New Zealand is the <a href="https://www.smh.com.au/business/levy-to-pay-for-5-6b-flood-bill-20110127-1a64x.html">flood levy</a> raised by the Australian government in 2011 to help pay for the devastating Queensland floods. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/flooded-home-buyback-scheme-helps-wash-away-the-pain-for-queenslanders-200242">Flooded Home Buyback scheme helps wash away the pain for Queenslanders</a>
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<p>For one year only, taxpayers with an annual income between A$50,000 and $100,000 paid an extra 0.5% levy, while those earning over $100,000 paid an additional 1%. Taxpayers living in the affected areas were exempt from the levy, which was designed to raise A$1.8 billion. </p>
<p>In my view, the Queensland levy provides an appropriate template for partly funding infrastructure remediation after the catastrophe of Cyclone Gabrielle. A flood levy on higher earners would make a significant contribution to recovery funds and would send a message of solidarity: we are all in this together. </p>
<p>Regardless of what the government decides, in the years ahead we need to debate how taxes may alleviate the harm suffered by people and businesses after natural disasters, fund remediation and – maybe most importantly – reduce carbon emissions.</p><img src="https://counter.theconversation.com/content/200705/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan Barrett does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Should the country go into debt or raise taxes to pay for disaster recovery? The best solutions might not be the most politically attractive – and that’s a problem.Jonathan Barrett, Associate Professor in Commercial Law and Taxation, Te Herenga Waka — Victoria University of WellingtonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1928232022-10-25T14:02:30Z2022-10-25T14:02:30ZThe UK is facing an economic crisis – here’s why it needs to find a global solution<figure><img src="https://images.theconversation.com/files/491630/original/file-20221025-14-i1ta6m.jpg?ixlib=rb-1.1.0&rect=0%2C84%2C5629%2C3663&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-great-britain-flag-united-kingdom-1842179239">Octus_Photography / Shutterstock</a></span></figcaption></figure><p>Recent <a href="https://news.sky.com/story/financial-markets-welcome-news-rishi-sunak-will-be-next-pm-12729240">changes</a> in the UK’s top job have had a positive effect on pound sterling and long-term sovereign bond yields. But the financial market reaction has been muted compared with the <a href="https://www.nytimes.com/2022/10/20/world/europe/liz-truss-britain-resigns.html">financial turmoil</a> blamed on former prime minister Liz Truss and ex-chancellor Kwasi Kwarteng in recent weeks. </p>
<p>After the <a href="https://www.bbc.co.uk/news/business-62920969">mini-budget</a> on September 23, the markets reacted to a bad policy: Truss’s strategy to undertake massive tax cuts without providing much certainty on <a href="https://ifs.org.uk/articles/mini-budget-response">how this would be funded</a>. Its <a href="https://theconversation.com/emergency-budget-announcement-expert-reaction-to-new-uk-chancellors-attempt-to-calm-financial-markets-192669">reversal</a> brought bond yields down from recent highs (essentially reducing the cost of government borrowing) and saw the pound appreciate. But overall, the market losses seen following the mini-budget have barely been recovered. </p>
<p>To investors, sound and stable economic policies matter much more than the person residing in Number 10. And that’s why, even with <a href="https://theconversation.com/prime-minister-rishi-sunak-who-is-he-and-how-did-he-end-up-with-the-top-job-in-british-politics-193151">a new prime minister</a>, recent market movements indicate investors continue to see more significant issues with the UK economy, both immediately and over the longer term.</p>
<p>In the short term, <a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">yields</a> on UK sovereign bonds have shot up after the <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-9624/">mini-budget</a>, increasing the government’s cost of borrowing. The lack of an accompanying forecast by the Office of Budgetary Responsibility (OBR) exacerbated this negative reaction. </p>
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<p>Before this, the Bank of England had been <a href="https://www.bankofengland.co.uk/news/2022/september/statement-from-the-governor-of-the-boe">contemplating a bond-selling exercise</a> to try to bring rising inflation back to its 2% target by reducing the supply of money in circulation (this is known as quantitative tightening). Instead, it had to quickly <a href="https://www.bankofengland.co.uk/news/2022/september/bank-of-england-announces-gilt-market-operation">change course</a> after the mini-budget. It not only postponed this tightening, but also restarted quantitative easing and bond purchases, promising to buy up to <a href="https://www.bankofengland.co.uk/news/2022/october/boe-widens-gilt-purchase-operations-to-include-index-linked-gilts">£10 billion in gilts</a> per day to address a related crisis among pension funds.</p>
<p>Two things will now determine future sovereign bond yield dynamics and dictate government borrowing costs. </p>
<p>First, clarity on how long the Bank of England plans to continue its policy of quantitative easing (buying bonds to keep yields low) before it reverts to quantitative tightening again. Markets are watching these actions very carefully and any suggestion that this support by the Bank will be <a href="https://www.ft.com/content/d9e46bb3-6bdd-416e-9ec6-e43b8af5fb30">cut off</a> could make traders and investors nervous. </p>
<p>Second, the government’s medium-term fiscal plan, currently scheduled for October 31, will also affect bond yields. Unlike the mini-budget, this plan will come with an in-depth assessment from the OBR, giving markets more information. Plus, the current chancellor, Jeremy Hunt, has brought some of the fiscal plan measures forward to ease market concerns. </p>
<p>It’s still unclear what kind of plan it will be, however. A debt-cutting strategy from Hunt and the new government headed by Rishi Sunak should assure the markets about the UK’s fiscal stability, but it’s still unknown whether this would happen via more taxes or less spending. Some <a href="https://academic.oup.com/oep/article/73/1/317/5612127?login=true">evidence</a> on what would be best for the economy supports raising capital income taxes (capital gains tax and inheritance tax) rather than cutting public spending or raising income taxes.</p>
<p>In the long term, the UK’s major problems are stagnating growth and lack of productivity. And if the new government addresses current problems by raising taxes and cutting spending – alongside <a href="https://www.theguardian.com/business/2022/oct/20/interest-rates-unlikely-to-rise-5-bank-of-england-ben-broadbent">higher interest rates</a> from the Bank of England – there will be more economic pain. </p>
<h2>Changing global economy</h2>
<p>Many countries are suffering similar issues to the UK, contributing to a weak <a href="https://www.imf.org/en/Blogs/Articles/2022/10/11/policymakers-need-steady-hand-as-storm-clouds-gather-over-global-economy?fbclid=IwAR3Gbb9uQgMwrIY2JzNPAeSDOmxlukLONbmBJ65rwI0CJ1Oob2jUXBUM6tU">global economic outlook</a> in general right now. After a prolonged period of historically <a href="https://www.bis.org/statistics/cbpol.htm">ultra-low interest rates</a>, increases – so-called normalisation of monetary policy – were <a href="https://data.oecd.org/interest/short-term-interest-rates-forecast.htm">expected</a> in most countries. But a sharp surge in inflation due to Russia’s invasion of Ukraine and pandemic-era supply chain issues have caused most central banks to scramble to <a href="https://www.ft.com/content/2496105a-d211-4abe-ab5d-46a91876428f">tighten monetary policy</a> even further by increasing rates more rapidly. </p>
<p><strong>Recent rate changes by central banks</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing changes in central bank base rates over the past decade, with a sharp rise in early 2022." src="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=275&fit=crop&dpr=1 600w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=275&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=275&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=346&fit=crop&dpr=1 754w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=346&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=346&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Interest rate changes by central banks in the UK, Japan, the US and the Eurozone between October 2012 and October 2022.</span>
<span class="attribution"><span class="source">Author's chart using Bank for International Settlements data.</span></span>
</figcaption>
</figure>
<p>These rate hikes and policy tightening strategies by central banks could create significant financial and fiscal instability. Already, the US Federal Reserve’s unwinding of its balance sheet from a peak of <a href="https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm">US$8.97 trillion</a> (£7.9 trillion) in April 2022, for example, caused the dollar to appreciate by more than <a href="https://www.marketwatch.com/investing/index/dxy">13%</a> in the last six months. This has created <a href="https://www.imf.org/en/Blogs/Articles/2022/01/10/blog-emerging-economies-must-prepare-for-fed-policy-tightening">challenges</a> for emerging market currencies, as well as major currencies – the yen, pound sterling and the euro – which have all <a href="https://www.x-rates.com/graph/?from=USD&to=EUR&amount=1">depreciated considerably</a> against the US dollar. </p>
<p>This has added to inflationary pressures, particularly in the Eurozone and UK, but it also affects <a href="https://www.ft.com/content/70e43592-30d0-4348-916b-673910ad7726">sovereign bond yields</a>, challenging economic stability in these countries. Since August, the cost of borrowing has more than doubled for many.</p>
<p><strong>The rising cost of government borrowing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing the rising cost of borrowing in recent months for governments in the UK, US, Germany, Italy, Canada, France and Greece." src="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=335&fit=crop&dpr=1 600w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=335&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=335&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=421&fit=crop&dpr=1 754w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=421&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=421&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">10-year sovereign bond yields from August to October 2022.</span>
<span class="attribution"><span class="source">Author's chart using Thomson Reuters data.</span></span>
</figcaption>
</figure>
<p>But to address rising inflation, even more central banks will want to shrink their balance sheets by selling bonds. The total size of the asset purchase programmes of the main four central banks alone is about <a href="https://www.atlanticcouncil.org/global-qe-tracker/">US$26.7 trillion</a>. With a weak global economy and these other financial fragilities, this is going to be a <a href="https://www.omfif.org/2022/10/central-banks-struggle-to-reduce-bloated-balance-sheets/">painful exercise</a> for the global economy. </p>
<p>Indeed, such tightening will increase the cost of government borrowing further, creating major issues, particularly for <a href="https://data.oecd.org/gga/general-government-debt.htm">highly leveraged</a> governments, and those still paying off <a href="https://www.brookings.edu/blog/future-development/2021/10/20/navigating-the-debt-legacy-of-the-pandemic/">pandemic-era</a> support such as the UK and Eurozone. </p>
<p>The UK specifically, is also dealing with a shift in the <a href="https://onlinelibrary.wiley.com/doi/10.1111/j.1758-5899.2010.00066.x">global economic centre of gravity</a> away from its economy. In less than two decades, the UK has shrunk in relative terms from being an economy larger than China to being about <a href="https://www.imf.org/external/datamapper/PPPGDP@WEO/OEMDC/ADVEC/WEOWORLD">nine times</a> smaller. And the pound no longer enjoys the same status as the US dollar, meaning financial markets will <a href="https://www.reuters.com/markets/europe/sterling-falls-fifth-day-turmoil-dogs-bond-market-2022-10-11/">punish it severely</a> if it steps out of line.</p>
<p>This means the new UK government faces a tricky task in reigniting global investor confidence in its economic stability, even with a new prime minister widely seen as a <a href="https://www.ft.com/content/465f2031-84ba-4faa-9f46-c3265166d973">steady hand</a>.</p><img src="https://counter.theconversation.com/content/192823/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The new government faces both short- and long-term problems when trying to reignite investor confidence in the UKMuhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1923652022-10-14T12:49:53Z2022-10-14T12:49:53ZHow to understand what’s going on with UK mortgage rates<figure><img src="https://images.theconversation.com/files/489544/original/file-20221013-11-jvye0w.jpg?ixlib=rb-1.1.0&rect=52%2C0%2C6928%2C4657&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">"Mortgage approved": an increasingly unlikely outcome in the current environment.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/approved-mortgage-loan-agreement-application-1397767763">Fabio Balbi / Shutterstock</a></span></figcaption></figure><p>The UK mortgage market has tightened as confidence in the economy has faltered in recent weeks. Lenders withdrew more than <a href="https://www.ft.com/content/d9a62b84-4a51-40d6-9002-a1310ce3c8dc">1,600 homeloan products</a> after the (then) chancellor Kwasi Kwarteng’s September mini-budget sent the UK economy into a <a href="https://www.theguardian.com/uk-news/2022/sep/30/how-kwasi-kwarteng-mini-budget-hit-uk-economy-in-numbers">tailspin</a>. </p>
<p>Rates on the mortgage products that are still available have risen to record levels – average two-year and five-year fixed rates have now <a href="https://moneyfacts.co.uk/news/mortgages/best-uk-residential-mortgage-rates-this-week/">passed 6%</a> for the first time since 2008 and 2010 respectively.</p>
<p>The Bank of England has intervened to try to <a href="https://inews.co.uk/news/bank-england-intervenes-uk-government-bond-market-1904744">calm the situation</a>. But this help currently has an <a href="https://www.theguardian.com/business/2022/oct/12/bond-buying-programme-will-end-on-friday-insists-bank-of-england">end date</a> of Friday 14 October, after which it’s unclear what will happen in the financial markets that influence people’s mortgage rates. </p>
<p>This is a crucial issue for a lot of people: <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/researchoutputssubnationaldwellingstockbytenureestimatesengland2012to2015/2020">28% of all dwellings</a> are owned with a loan, with mortgage payments eating up about <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/datasets/housepriceindexannualtables2039">a sixth of household income</a>, on average.</p>
<p>Looking at how the market has developed over time can help to explain how we got here and where we are going – which is basically headfirst into a period of high interest rates, low loan approvals and plateauing house prices.</p>
<p>All financial markets are driven by information, confidence and cash. Investors absorb new information which feeds confidence or drives uncertainty, and then they choose how to invest money. As the economy falters, confidence erodes and the interest rates that banks must pay to access funding in financial markets – which influence mortgage rates for borrowers – become unpredictable. </p>
<p>Banks do not like such uncertainty and they do not like people defaulting on their loans. Rising interest rates and uncertainty increase their risk, reduce the volume of mortgage sales and place downward pressure on their profits.</p>
<h2>How banks think about risk</h2>
<p>Once you understand this, predicting bank behaviour in the mortgage market becomes a lot easier. Take the period before the global financial crisis of 2008 as an example. In the early 1990s, controls over mortgage lending were relaxed so that, by the early 2000s, mortgage product innovation was a firm trend. </p>
<p>This led to mortgages being offered for 125% of a property’s value, and banks lending people four times their annual salary (or more) to buy a home and allowing self-employed borrowers to “self-certify” their incomes.</p>
<p>The risks were low at this time for two reasons. First, as mortgage criteria became more liberal, it brought more money into the market. This additional money was chasing the same supply of houses, which increased house prices. In this environment, even if people defaulted, banks could easily sell on repossessed houses and so default risks were less of a concern. </p>
<p>Second, banks began to offload their mortgages into the financial markets at this time, passing on the risk of default to investors. This freed up more money for them to lend out as mortgages.</p>
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Read more:
<a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">How bonds work and why everyone is talking about them right now: a finance expert explains</a>
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<p>The Bank of England’s base rate also <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">dropped throughout this period</a> from a high of 7.5% in June 1998 to a low of 3.5% in July 2003. People desired housing, mortgage products were many and varied, and house prices were rising – <a href="https://www.researchgate.net/publication/227429691_The_Sub-Prime_Crisis_the_Credit_Squeeze_and_Northern_Rock_The_Lessons_to_Be_Learned">perfect conditions</a> for a booming housing market. Until, of course, the global financial crisis hit in 2008.</p>
<p>The authorities reacted to the financial crisis by firming up the mortgage rules and going back to basics. This meant increasing the capital – or protection – that banks had to hold against the mortgages they had on their books, and <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2706485">strengthening the rules</a> around mortgage products. In essence: goodbye self-certification and 125% loans, hello lower income multiples and bulked-up bank balance sheets.</p>
<p>The upshot of these changes was fewer people could qualify to borrow to buy a home, so average UK house prices dropped from more than £188,000 in July 2007 to around £157,000 in January 2009. The damage was so deep that they had only partially recovered some of these losses to reach £167,000 by January 2013.</p>
<p><strong>Average UK house price, Jan 2005-July 2022:</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing average UK house prices between January 2005 and July 2022." src="https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=236&fit=crop&dpr=1 600w, https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=236&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=236&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=297&fit=crop&dpr=1 754w, https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=297&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/489557/original/file-20221013-23-4hzst5.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=297&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/july2022">HM Land Registry, Registers of Scotland, Land and Property Services Northern Ireland, Office for National Statistics – UK House Price Index</a></span>
</figcaption>
</figure>
<h2>New constraints</h2>
<p>Of course, prices have boomed again more recently. This is partly because banks had slowly <a href="https://www.unbiased.co.uk/news/mortgages/its-back-the-return-of-the-100-mortgage">started to relax</a>, although with less flexibility and more regulation than before the global financial crisis. This reduction in flexibility cut product choice, but low interest rates and low monthly payments have encouraged individuals to take on more debt and banks to grant more mortgages.</p>
<p>Availability of loans fuels house prices so the cycle starts again, although within a more regulated market this time. But the result has been largely the same: average house prices have risen to <a href="https://www.theguardian.com/business/2022/oct/07/fear-panic-housing-market-bishops-stortford-mini-budget-mortgages#:%7E:text=The%20average%20UK%20house%20price%20is%20now%20%C2%A3293%2C835">just shy of £300,000</a> and the total value of <a href="https://www.statista.com/statistics/428498/gross-mortgage-lending-united-kingdom/">gross mortgage lending</a> in the UK has grown from £148 billion in 2009 to £316 billion by 2021.</p>
<p>But when new information hit the markets – starting with Russia’s invasion of Ukraine earlier this year – everything changed and confidence tanked. The resulting supply-side constraints and spiking fuel prices have stoked inflation. And the <a href="https://www.imf.org/en/Blogs/Articles/2022/08/10/central-banks-hike-interest-rates-in-sync-to-tame-inflation-pressures">very predictable</a> response of the Bank of England has been to increase interest rates.</p>
<p>Why? Because increasing interest rates is supposed to stop people spending and encourage them to save instead, taking the heat out of the economy. However, this rise in interest rates, and therefore <a href="https://www.mortgagesolutions.co.uk/news/2022/10/05/monthly-average-mortgage-payments-to-rise-300/">monthly mortgage payments</a>, is happening at a time when people’s disposable income is already being <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/energypricesandtheireffectonhouseholds/2022-02-01">drastically reduced</a> by rising fuel prices.</p>
<figure class="align-center ">
<img alt="Man reading newspaper headlines about mortgages." src="https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/489733/original/file-20221014-25-vph4v5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Recent political and economic events have tightened many people’s budgets as mortgage rates have risen significantly.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/man-reading-mortgage-headlined-newspaper-558116308">garagestock / Shutterstock</a></span>
</figcaption>
</figure>
<h2>Mortgage market outlook</h2>
<p>So what of the mortgage markets going forward? The present economic situation, while completely different from that of the 2008 financial crisis, is borne of the same factor: confidence. The political and economic environment – the policies of the <a href="https://news.sky.com/story/mini-budget-why-financial-markets-have-been-spooked-by-chancellors-growth-plan-12703889">Truss administration</a>, Brexit, the war in Ukraine, rising fuel costs and inflation – has shredded investor confidence and increased risk for banks.</p>
<p>In this environment, banks will continue to protect themselves by tightening product ranges while increasing mortgage rates, deposit sizes (or loan-to-values) and the admin fees they charge. Loan approvals are already <a href="https://www.ey.com/en_uk/news/2022/09/uk-mortgage-lending-set-to-fall-in-october-ey-item-club-comments">falling</a> and cheap mortgages have rapidly disappeared. </p>
<p><a href="https://www.reuters.com/markets/europe/uk-house-price-growth-slows-weakest-since-july-2020-rics-2022-10-12/#:%7E:text=Enquiries%20by%20new%20buyers">Demand for homeloans</a> will also keeping falling as would-be borrowers are faced with a reduced product range as well as rising loan costs and monthly payments. Few people make big financial decisions when uncertainty is so high and confidence in the government is so low. </p>
<p>Optimistically, the current situation will cause UK house prices to plateau, but given the <a href="https://www.theguardian.com/business/live/2022/oct/14/kwasi-kwarteng-returns-early-imf-markets-price-more-u-turns-business-live">continued uncertainty</a> arising from government policy, it’s realistic to expect falls in certain areas as financial market volatility continues.</p><img src="https://counter.theconversation.com/content/192365/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Webb does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Borrowers want to know when soaring mortgage rates will go down again.Robert Webb, Professor of Banking & Applied Economics, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1905862022-09-14T15:27:58Z2022-09-14T15:27:58ZHow the UK energy crisis plan will affect bills and price inflation — an economist explains<figure><img src="https://images.theconversation.com/files/484648/original/file-20220914-11-y0sihp.jpg?ixlib=rb-1.1.0&rect=17%2C43%2C5810%2C3835&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The government wants to ease the burden of the rising cost heat and power on households and businesses this winter.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/one-man-worried-about-bills-reading-2125548260">tommaso79 / Shutterstock</a></span></figcaption></figure><p><em>A rapid rise in energy prices for households and businesses this year has led the UK government to outline its <a href="https://www.gov.uk/government/speeches/pm-liz-trusss-opening-speech-on-the-energy-policy-debate">energy price guarantee</a> plan, designed to ensure a typical household will pay no more than £2,500 annually for two years from October 1 2022. Businesses will have their energy costs guaranteed for six months from the same date. After this, the government says it will target “vulnerable sectors” such as hospitality with more help, but has not yet provided more details.</em></p>
<p><em>Any additional energy costs beyond the government’s guarantee will be covered by the government. And while it has not yet released any financial information about the plan, this could cost more than £100 billion in the first year alone, according to <a href="https://ifs.org.uk/articles/response-energy-price-guarantee">figures</a> based on 2019 consumption from the Institute for Fiscal Studies.</em></p>
<p><em>We asked an economist to explain the plan and its likely impact on inflation, as well as who will foot the bill for the guarantee.</em> </p>
<h2>How will the new plan address the UK energy crisis?</h2>
<p>While this new plan is a notable action and an improvement on Ofgem’s previous <a href="https://www.ofgem.gov.uk/publications/ofgem-updates-price-cap-level-and-tightens-rules-suppliers">£3,549 price cap</a>, it is important to remember that both figures are only examples. The government <a href="https://www.moneysavingexpert.com/news/2022/09/energy-bills-price-freeze-cost-of-living-government-liz-truss-/#:%7E:text=standing%20charges%20and%20unit%20rates">will freeze</a> the price per unit used and the standing charge (the price you pay for your supplier to maintain wires and send someone out to read your meter, among other things). This means there is no overall cap on what a consumer can be charged – your bill will depend on what you use. So, any potential savings from the £2,500 guarantee – the government says an average user will save <a href="https://www.gov.uk/government/publications/energy-bills-support/energy-bills-support-factsheet-8-september-2022">at least £1,000 per year</a> – are hypothetical and will depend on individual household and business energy use.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/484594/original/file-20220914-11-5of4ds.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Energy costs will still rise above current levels under the government’s new plan.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/photo-realistic-energy-price-rise-sign-68213851">Becky Stares / Shutterstock</a></span>
</figcaption>
</figure>
<h2>Will the government’s plan cut inflation? If so, by how much?</h2>
<p>By cushioning the blow of high gas prices in this way, the government hopes to curb inflation – currently close to a 40-year high at 9.9% – by up to 5%. Energy’s contribution to total inflation was around 1.5% in 2021. Russia’s invasion of Ukraine earlier this year caused gas prices to rise by 95.7% (subsequently pushing electricity prices up by 54% due to the amount of gas-fired power generation used in the UK). This pushed energy’s contribution to annual inflation to 1.9% in April 2022.</p>
<p>If the government had frozen energy costs based on the current average household bill of £1,971, the rate of inflation would have been reduced by 3.9%, according to the <a href="https://www.ippr.org/blog/freezing-the-energy-price-cap-could-fight-inflation-and-support-households">Institute for Public Policy Research</a>. But under the new plan, a typical household will now see a 7% increase in energy costs in the first year from current levels, due to a previous <a href="https://www.bbc.co.uk/news/business-61592496">£400 rebate</a>, followed by a 27% increase in the second year.</p>
<p>Without firm figures from the government, it’s difficult to pinpoint the exact impact of its plan, particularly since there are other factors at play. Inflation is also affected by shocks such as the supply chain disruption caused by the pandemic. Along with Russia’s invasion of Ukraine and the resulting effect on the supply of certain commodities, such issues have caused the UK to experience demand-pull inflation. This is when supply cannot meet growing demand, causing prices to increase. A change in any of these factors would affect the rate of inflation.</p>
<p>The plan could also indirectly affect inflation. Businesses have been offered an “equivalent guarantee”, according to Truss. As such, we can assume they may also still see an average price rise over the next six months, followed by further uncertainty in the future. Some will push additional energy costs on to consumers through higher prices for goods and services. This will create what is called cost-push inflation, where prices rise as a result of the costs of materials and labour. Those businesses that do not pass on energy cost increases may have to close.</p>
<h2>How long will any effects take to feed through to the inflation rate, and why?</h2>
<p>The plan could have an impact on people’s finances in the short term by setting an average energy cost. But the effects will take time to feed through into price inflation as households and businesses adjust consumption and investment in response to the policy. The government’s monthly inflation estimates could start to show results around three quarters from now.</p>
<h2>Who will pay for the plan?</h2>
<p>Liz Truss has stated that the government will borrow to fund its energy crisis plan. At present, 85% of <a href="https://commonslibrary.parliament.uk/coronavirus-government-debt-an-explainer/">government borrowing</a> comes from selling gilts and bills – investment products that are essentially loans to the seller, in this case the government – to investors like pension funds and insurers.</p>
<p>Repaying these loans will mean raising taxes and essentially asking future generations to fund today’s consumption. Each extra £1 households spend on energy is likely to cost the taxpayer 75p over the next year, according to the <a href="https://ifs.org.uk/articles/response-energy-price-guarantee">Institute for Fiscal Studies</a>.</p>
<p>Instead, some argue that energy firms should be taxed to cover the cost. These companies are expected to generate <a href="https://www.reuters.com/business/energy/uk-gas-electricity-industry-may-make-170-bln-pounds-excess-profits-bbg-2022-08-30/">£170 billion</a> in extra profits over the next two years as a result of rising prices.</p>
<p>Alternatively, adjusting the unit cost cap based on different levels of use, rather than applying a blanket cap based only on average usage, would require high energy users to pay more per unit and could encourage a drop in consumption.</p>
<h2>Will this additional borrowing affect inflation?</h2>
<p>The policy will certainly increase the supply of money in the UK by pumping an estimated £100 billion into the energy sector through borrowing in its first year. It will be an expansionary fiscal policy, which is good for growth but may create more demand-pull inflation. </p>
<p>At the same time, the Bank of England is likely to continue to try to control inflation by raising interest rates. Higher interest rates mean rising borrowing costs for everyone, including the government. </p>
<p>The government already has a lot of loans already. Its <a href="https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicspending/bulletins/ukgovernmentdebtanddeficitforeurostatmaast/march2022">gross debt</a> currently stands at £2,365.4 billion, equal to 99.6% of gross domestic product. With the <a href="https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/bulletins/publicsectorfinances/june2022">current inflation rate</a> already raising the cost of borrowing, further unplanned borrowing will add more pressure. </p>
<p>While the energy crisis plan creates a little breathing room for the government, it is a blanket solution. A more targeted approach could have had better results. It will take much more unconventional policy making than this to solve the current cost of living crisis.</p><img src="https://counter.theconversation.com/content/190586/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nasir Aminu does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>How Liz Truss’s energy cost freeze could affect what you pay for heat, power and even other goods and services.Nasir Aminu, Senior Lecturer in Economics and Finance, Cardiff Metropolitan UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1836602022-05-30T14:11:31Z2022-05-30T14:11:31ZGhana’s debt: the pros and cons of borrowing abroad versus at home<figure><img src="https://images.theconversation.com/files/466001/original/file-20220530-12-50lufn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ghana's borrowing has it on the verge of debt distress</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>A government which decides to borrow – either because it has programmed a budget deficit or needs to refinance maturing debts – faces two, non-mutually exclusive possibilities: borrow domestically in the local currency or borrow externally in a foreign currency.</p>
<p>Developed countries borrow predominantly at home and in their currencies. This is because they have deep domestic financial markets. Developing countries are different. Their governments are more likely to supplement domestic borrowing with debt from abroad in foreign currencies. </p>
<p>There are a few options when borrowing from abroad: from other countries (bilateral), from multilateral institutions like the International Monetary Fund, World Bank and the African Development Bank, or from the international capital markets. </p>
<p>Ghana taps both domestic and overseas financial markets. It issued its first Eurobond in 2007, and since then has <a href="https://www.bloomberg.com/news/articles/2020-02-04/ghana-markets-sub-saharan-africa-s-longest-eurobond-to-date">borrowed</a> over US$15 billion. Since 2013 its external debt has been greater than its domestic debt. As of March 2022, the <a href="https://www.ghanaweb.com/GhanaHomePage/business/What-Akufo-Addo-said-about-Ghana-s-increasing-debt-in-2012-1545188">total debt stock</a> was US$ 55 billion (78% of GDP) . The <a href="https://allafrica.com/stories/202204260604.html#:%7E:text=Also%2C%20the%20external%20component%20of,38.7%20per%20cent%20of%20GDP.">external component</a> was estimated at US$ 28.4 billion representing 51.6% share of the total. </p>
<p>Domestic debt has been more expensive than external debt for a long time. The cost of borrowing from international capital markets ranges between 7% and 11% compared to <a href="https://www.bog.gov.gh/treasury-and-the-markets/interbank-interest-rates/">domestic market’s</a> 18%-22% . </p>
<h2>Borrowing local is expensive for Ghana</h2>
<p>A number of factors drive higher local borrowing costs. Here are some, though the list isn’t exhaustive.</p>
<p>First, local borrowing isn’t concessional. Concessional loans come with low interest and normally a grace period before principal repayments begin. But these loans are available only to poor countries that meet the criteria. Ghana doesn’t meet the criteria.</p>
<p>The second reason is related to high inflation and low domestic savings. Ghana’s <a href="https://www.ghanabusinessnews.com/2022/05/11/ghana-inflation-rate-for-april-2022-accelerates-to-23-6-from-19-4/">inflation rate </a>for April 2022 was 23.6%. No investor will invest at a rate lower than inflation because they will be making losses (negative real interest rate). Therefore, for the government to be able to attract investors, it will have to charge higher interest (usually above inflation rate).</p>
<p>A third reason that local debt is expensive is that Ghana’s domestic debt market is not yet deep and liquid. The small domestic debt market and a limited pool of funds means that restricts government to borrowing short-term and at higher interest rates.</p>
<p>The other reason foreign investors expect higher interest rates is because developing countries have a history of mismanaging their economies. Ghana has had its <a href="https://www.theafricareport.com/142654/ghanas-worsening-debt-market-access-means-imf-relief-needed-economists/">challenges</a> of economic management . This is evident in the <a href="https://www.theafricareport.com/174809/ghana-policy-credibility-depends-on-imf-package-after-moodys-downgrade/">number of times </a>the country had resorted to the IMF for a bailout. For the risk that foreign investors take, they expect a higher interest rates to compensate for the perceived risk.</p>
<h2>Borrowing abroad</h2>
<p>Commercial foreign loans come with lower interest rates than domestic loans debt.</p>
<p>This is partly because external borrowing provides access to a vast pool of long-term funds held by international development banks or investors in international capital markets. This is true of loans with concessional or nonconcessional terms.</p>
<p>Longer maturities – which means longer periods of time over which debt can be settled – are also obtainable in foreign capital markets. This is because they are deeper and more sophisticated than domestic markets. </p>
<p>Long-term borrowing reduces public debt roll-over risks. For its part short-term borrowing worsens roll-over risks.</p>
<p>Foreign borrowing is routinely defended on the grounds that it avoids crowding out private borrowing and investment, which is what happens when domestic borrowing drives up interest rates. This argument is given force especially when domestic savings are very low or the outstanding domestic debt stock is already huge, and it is feared that the marginal cost of additional debt would have to keep rising to persuade local bondholders to lend more money to the government.</p>
<h2>Grounds for coming home</h2>
<p>There is a case to be made against foreign-currency loans. The factors include:</p>
<p><strong>Foreign exchange risk</strong>: Even if the interest rate and other terms of a foreign loan are more favourable than domestic debt, the foreign loan might still be more expensive in the end. This is due to the inherent foreign exchange risk, whereby the cost of servicing the debt in local currency terms increases whenever the exchange rate depreciates (in a flexible or managed exchange rate regime) or is devalued (in a currency peg regime).</p>
<p>This worsens the burden of the debt on government revenue which is in local currency and raises debt service costs. At the same time, depreciation (or devaluation) raises the home currency value of outstanding foreign debt and depresses the foreign currency value of domestic revenue. This can lead to a country’s debt profile looking more vulnerable.</p>
<p>Investors may also perceive this situation as a deterioration of the government’s credit or default risk and demand higher interest rates on foreign borrowing. </p>
<p>By comparison, domestic debt doesn’t expose the government to currency risk and is therefore safe.</p>
<p><strong>Crowding-out effects</strong>: When money raised abroad flows into the country it must be exchanged for the domestic currency which risks causing inflation as the inflows will result in an increase in money supply. </p>
<p>External borrowing can also trigger an appreciation of the domestic currency, thereby squeezing out exporters.</p>
<p><strong>Debt service outflows</strong>: Interest paid on external debt is an outflow of resources abroad to foreigners, whose income and consumption are taxed by their own governments. It is not a domestic transfer that could yield tax revenue to the government. Accordingly, the domestic economy is worse off when foreign debt is serviced than when domestic debt is serviced. That is why there is the need to limit foreigners holding of the domestic bond.</p>
<p><strong>Bigger debt crisis risk</strong>: When overdone, all forms of borrowing can plunge a country into a debt crisis or lead to a default. However, the risk of a crisis is bigger with foreign debt. First, what a government owes to foreign investors can balloon without government taking on a new debt. The cause would be a sharp weakening of the domestic currency against the currency in which the foreign debt is denominating.</p>
<p><strong>Sovereignty</strong>: Dependence on external funds gives foreign creditors influence over domestic policy choices. This is facilitated, for example, through conditions attached to concessional loans given by international agencies, especially the IMF and World Bank.</p>
<p>In addition, disputes over foreign debt are typically adjudicated abroad whereas domestic debt is governed by domestic law, which the government has influence over.</p>
<p>Besides, to the extent that it is true, the argument that external sovereign debt acts as a disciplinary device over domestic policy decisions has a flip side. This is the fear that it could make a government beholden to foreign bondholders, whose expectations and interests would influence national policies, perhaps disproportionately and to the detriment of citizens’ interests.</p><img src="https://counter.theconversation.com/content/183660/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Adu Owusu Sarkodie does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There are a number of reasons why Ghana’s domestic borrowing is more expensive than foreign debt.Adu Owusu Sarkodie, Lecturer, Department of Economics, University of GhanaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1652982021-08-11T12:29:32Z2021-08-11T12:29:32ZCredit ratings are punishing poorer countries for investing more in health care during the pandemic<figure><img src="https://images.theconversation.com/files/415530/original/file-20210810-19-178x8bn.jpg?ixlib=rb-1.1.0&rect=175%2C146%2C4607%2C3105&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Morocco wanted to spend more on health care. As a result, its credit rating was cut. </span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/VirusOutbreakMoroccoVaccination/14a66c3698cb4f118b52942707c17d6a/photo?Query=Morocco%20covid-19&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=210&currentItemNo=53">AP Photo/Abdeljalil Bounhar</a></span></figcaption></figure><p>Economic recovery from the COVID-19 pandemic <a href="https://www.un.org/development/desa/dspd/2020/07/recovering-from-covid19/">depends on sustained investment</a> in health care and social services. But while rich countries like the U.S. <a href="https://www.imf.org/en/Topics/imf-and-covid19/Fiscal-Policies-Database-in-Response-to-COVID-19">can borrow and spend relatively easily</a>, low-income nations face a major obstacle: their credit ratings. </p>
<p>A credit rating, like a credit score, <a href="https://theconversation.com/why-credit-ratings-matter-and-why-they-cant-be-ignored-69361">is an assessment of the ability of a borrower</a> – whether it’s a company or a government – to repay its debts. Lower credit ratings drive up the cost of borrowing.</p>
<p>This threat prompted <a href="https://group30.org/publications/detail/4799">some poorer countries to avoid tapping investors</a> for vital financing during the pandemic, while other governments that made plans to spend more on public services <a href="https://www.reuters.com/article/us-ratings-sovereign-idUKKBN2B92OY">were hit with credit ratings downgrades</a> from private companies. </p>
<p>My <a href="https://sase.confex.com/sase/2021/meetingapp.cgi/Paper/17513">forthcoming research</a> shows that when credit ratings fall, countries tend to spend less on health care. This should be a cause for concern as the delta variant of the coronavirus <a href="https://coronavirus.jhu.edu/map.html">drives up case counts across the world</a>. </p>
<h2>Punished for health care spending</h2>
<p>A wide gap has emerged between rich and poor countries in terms of how much they are spending to fight the coronavirus’s impact and shore up their health care infrastructure. </p>
<p>Governments in rich countries <a href="https://www.brookings.edu/opinions/how-to-balance-debt-and-development/">have provided trillions of dollars</a> in direct and indirect support for their economies, on average about 24% of their gross domestic product. Developing economies, on the other hand, have been able to spend only a tiny fraction of that, an average of about 2% of their GDP. </p>
<p>Recent research found that a country’s credit rating <a href="https://www.nber.org/papers/w27461">was the largest factor</a> in how much a government spent on COVID-19 relief. That is, the lower a country’s rating, the less it was able to spend on health care and other social services. </p>
<p>For instance, Ivory Coast and Benin are the only two countries in sub-Saharan Africa that <a href="https://www.brookings.edu/opinions/how-to-balance-debt-and-development/">have been able to borrow in international markets</a> since the pandemic began. Others chose not to borrow, at least in part, it seems, <a href="https://group30.org/images/uploads/publications/G30_Sovereign_Debt_and_Financing_for_Recovery_after_the_COVID-19_Shock-_Preliminary_Report_1.pdf">out of fear of the ratings downgrades</a> that might result. This has prevented them from financing much-needed spending. </p>
<p>The fear is justified. Countries that planned to increase spending, such as Morocco and Ethiopia, were punished for it. Morocco’s credit rating, for example, was downgraded to speculative grade, or “junk,” by <a href="https://www.reuters.com/article/morocco-rating-fitch-idUSL8N2HE5YL">Fitch</a> and <a href="https://www.bloomberg.com/news/articles/2021-04-02/morocco-cut-to-junk-by-s-p-kn0qnt09">Standard & Poor’s</a> because of its plan to spend more on social services. <a href="https://www.worldbank.org/en/news/feature/2016/08/17/analysis-how-do-credit-downgrades-affect-short-term-government-borrowing">The ratings cuts will make it much harder</a>, and more expensive, for it to borrow from international investors.</p>
<p>And Moody’s Investors Service <a href="https://www.reuters.com/article/ethiopia-bonds/update-1-moodys-downgrade-over-g20-common-framework-hits-ethiopian-bonds-idUSL5N2N52KD">slashed Ethiopia’s credit rating</a> after the country sought debt relief from a <a href="https://www.imf.org/en/About/FAQ/sovereign-debt#Section%205">new Group of 20 program</a> so that it <a href="https://www.bloomberg.com/news/articles/2021-07-07/ethiopia-in-negotiations-to-restructure-1-billion-more-of-debt-kqte6iuj?sref=Hjm5biAW">could spend more on supporting</a> its economy and citizens.</p>
<p>Overall, despite spending far less during the pandemic, poorer countries <a href="https://www.reuters.com/article/us-ratings-sovereign-idUKKBN2B92OY">were much more likely than wealthier ones to see their credit ratings cut</a> by Fitch, Standard & Poor’s and Moody’s – the three biggest private credit rating agencies. </p>
<p>Low-income countries are therefore forced to choose between keeping their credit ratings stable and undertaking critical social services spending. </p>
<p>In my own research, which is currently under peer review, I looked at ratings changes across a group of 140 countries from 2000 to 2018. I found that downgrades in credit ratings lowered public spending on health care. </p>
<h2>The IMF’s rating system</h2>
<p>Even the International Monetary Fund, which is the main global agency that oversees development finance, uses a rating system that tends to penalize governments for any increase in public spending. That includes spending invested in their health care systems. </p>
<p>The IMF evaluates the creditworthiness of countries through a system it calls its <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">debt sustainability framework</a>. Countries are classified into three levels of “<a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">credit capacity</a>” - strong, medium or weak. </p>
<p>Weak countries are deemed to have a low ability to handle additional debt based on their current levels of indebtedness. No distinction is made <a href="https://www.brettonwoodsproject.org/2017/12/debt-sustainability-review-tinkering-around-edges-crises-loom/">between debt</a> that was a result of important long-term investments in social services like health and education and debt incurred by more wasteful spending. Countries are then required by the IMF to improve their ratings as a condition of aid, such as by putting the focus on debt repayment, short-term economic objectives and across-the-board spending cuts. </p>
<p>An op-ed in The Lancet <a href="https://doi.org/10.1016/S2214-109X(14)70377-8">blamed similar IMF-induced austerity</a> in the early 2000s for a reduction in health care spending in Guinea, Liberia and Sierra Leone, leaving them susceptible to the Ebola crisis in 2014. The three were the <a href="https://www.theguardian.com/world/2021/jun/19/guinea-ebola-outbreak-declared-over-by-who">worst-affected countries</a> in an epidemic that lasted two years and led to over <a href="https://www.cdc.gov/vhf/ebola/history/2014-2016-outbreak/index.html">11,000 deaths</a>. </p>
<h2>Ratings reform</h2>
<p>The IMF recently announced a <a href="https://www.nytimes.com/2021/07/09/us/politics/g20-imf-vaccines.html">plan to issue US$650 billion</a> in reserve funds that low-income countries can use to buy vaccines and expand health care. While that should help more countries not to have to choose between credit ratings and the well-being of their citizens during the pandemic, it’s only a short-term fix.</p>
<p>A recent United Nations report <a href="https://undocs.org/A/HRC/46/29">urged reform of how private credit ratings agencies are regulated</a>, arguing they lack accountability and make it hard for poor countries to fulfill their human rights obligations. A proposal to put a moratorium on the sovereign credit ratings of debt-burdened countries during crises <a href="https://www.reuters.com/article/us-emerging-debt-ratings/credit-downgrade-buffer-proposed-for-poor-nations-seeking-debt-help-study-idUSKCN2DG0US">would also help provide a buffer</a>. </p>
<p>Permanent changes in how the IMF and private credit ratings agencies evaluate debt, however, may be needed so that they’re not penalizing countries for making important investments in health care and other public services. That would help countries can build their health care infrastructure so that they aren’t caught off guard by the next pandemic.</p>
<p>[<em>The Conversation’s Politics + Society editors pick need-to-know stories.</em> <a href="https://theconversation.com/us/newsletters/politics-weekly-74/?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=politics-need-to-know">Sign up for Politics Weekly</a>._]</p><img src="https://counter.theconversation.com/content/165298/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ramya Devan does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Low-income countries that sought to spend more on health care during the pandemic have been hit with ratings downgrades, while others avoided borrowing entirely.Ramya Devan, Professor of Economics, Stockton UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1506062020-12-02T13:26:10Z2020-12-02T13:26:10ZThe morality of canceling student debt<figure><img src="https://images.theconversation.com/files/372083/original/file-20201130-21-1boo981.jpg?ixlib=rb-1.1.0&rect=7%2C28%2C4770%2C2507&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Students pulling a heavy ball representing the total outstanding student debt in the U.S. at over $1.5 trillion.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/students-pull-a-mock-ball-chain-representing-the-1-4-news-photo/613631652?adppopup=true">PAUL J. RICHARDS/AFP via Getty Images</a></span></figcaption></figure><p>President-elect <a href="https://joebiden.com/beyondhs/">Joe Biden promised to forgive</a> at least some student debt during his campaign, and he now supports immediately canceling <a href="https://www.npr.org/sections/biden-transition-updates/2020/11/17/935743741/biden-wants-to-help-pay-some-student-loans-but-theres-pressure-to-go-further">US$10,000</a> per borrower as part of COVID-19 relief measures.</p>
<p>Such proposals are likely to be quite popular. A poll from 2019 found that <a href="https://thehill.com/hilltv/rising/461106-majority-of-voters-support-free-college-eliminating-student-debt">58% of voters support</a> canceling all federal student debt.</p>
<p>But there are <a href="https://www.bostonglobe.com/2020/11/22/opinion/student-debt-bailout-would-be-unjust">those who question the idea</a> of debt forgiveness and call it unfair to those who never took out student debt or already paid it off.</p>
<p>As an <a href="https://lib.dr.iastate.edu/do/search/?q=author_lname%3A%22Padgett-Walsh%22%20author_fname%3A%22Kate%22&start=0&context=1759512&facet=">ethicist</a> who studies the morality of debt, I see merit in the question: Should student debt be canceled?</p>
<h2>The moral case against canceling</h2>
<p>Educational debt is often regarded as an investment in one’s future. Millennials with a B.A., for instance, typically earn <a href="https://www.bls.gov/careeroutlook/2020/data-on-display/education-pays.htm">$25,000</a> more than those with a high school diploma. College education is also generally correlated with a variety of positive life outcomes, including <a href="https://www.sciencedirect.com/science/article/pii/S0167629616301382">physical</a> and <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3298813/">mental</a> health, <a href="https://www.annualreviews.org/doi/abs/10.1146/annurev.soc.012809.102503">family stability</a> and <a href="https://www.aeaweb.org/articles?id=10.1257/jep.25.1.159">career satisfaction</a>. </p>
<p>Given the benefits of college education, <a href="https://www.brookings.edu/blog/up-front/2019/11/12/five-facts-about-student-loans/">canceling student debt appears</a> to some as a giveaway for those who are already on their way to becoming well-off. </p>
<p>Canceling debt also seems to violate the moral principle of following through on one’s promises. Borrowers have a moral duty to fulfill their loan agreements, the philosopher <a href="https://pdfs.semanticscholar.org/ff5d/112a814a2016f045f63a31755792c757e8b8.pdf">Immanuel Kant</a> argued, because reneging on promises is disrespectful to oneself and others. Once people have promised to do something, he noted, others rely upon that promise and expect them to follow through. </p>
<p>In the case of federal student loans, a borrower signs a promissory note agreeing to pay back the government and, ultimately, the taxpayers. And so student borrowers seem to have a moral duty to pay their debts unless mitigating circumstances like injury or illness arise.</p>
<h2>The moral case for canceling</h2>
<p>Fairness and respect, however, also demand that society addresses the magnitude of student debt today, and especially the burdens it imposes on low-income, first-generation and Black borrowers. </p>
<p>Young people today start their adult lives burdened with much more student debt than previous generations. Almost <a href="https://ticas.org/wp-content/uploads/legacy-files/pub_files/qf_about_student_debt.pdf">70% of college students</a> now borrow to attend college, and the average size of their debt has risen since the mid-90s from less than <a href="https://ticas.org/wp-content/uploads/legacy-files/pub_files/qf_about_student_debt.pdf">$13,000 to about $30,000</a> today. </p>
<p>As a result, total outstanding student debt has jumped to over <a href="https://www.newyorkfed.org/microeconomics/topics/student-debt">$1.5 trillion</a>, making it the <a href="https://heller.brandeis.edu/iasp/pdfs/racial-wealth-equity/racial-wealth-gap/stallingdreams-how-student-debt-is-disrupting-lifechances.pdf">second largest</a> form of debt in the U.S. after mortgages. </p>
<p>This explosion in student debt raises two significant moral concerns, as my student <a href="https://link.springer.com/article/10.1007/s10790-020-09770-1?wt_mc=Internal.Event.1.SEM.ArticleAuthorOnlineFirst&utm_source=ArticleAuthorOnlineFirst&utm_medium=email&utm_content=AA_en_06082018&ArticleAuthorOnlineFirst_20201001">Justin Lewiston and I argue in an article</a> published last month by The Journal of Value Inquiry. </p>
<p>The first concern is that the distribution of costs and benefits is very unequal. Fairness requires equal opportunity, as the philosopher <a href="https://plato.stanford.edu/entries/rawls/">John Rawls</a> argued. Yet, while borrowing for education is supposed to create opportunities for students from disadvantaged backgrounds, those opportunities often fail to materialize due to educational challenges and wage gaps in the labor market.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/372084/original/file-20201130-17-1pnwm7f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Students hold a demonstration in New York to protest against ballooning student loan debt.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/students-hold-placards-as-they-stage-a-demonstration-at-the-news-photo/496932252?adppopup=true">Photo by Cem Ozdel/Anadolu Agency/Getty Images</a></span>
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<p>Data show that low-income students, first-generation students and Black students face much greater struggles in repaying their loans. About 70% of those in <a href="https://www.americanprogress.org/issues/education-postsecondary/reports/2017/12/14/444011/student-loan-defaulters/">default</a> are first-generation students, and 40% come from low-income backgrounds. Twenty years after college, when white borrowers have repaid 94% of their loans, the typical Black student has been able to <a href="https://heller.brandeis.edu/iasp/pdfs/racial-wealth-equity/racial-wealth-gap/stallingdreams-how-student-debt-is-disrupting-lifechances.pdf">repay only 5%</a>. </p>
<p>These repayment and default rates reflect significantly lower <a href="https://nscresearchcenter.org/signaturereport16/">graduation rates</a> for students in those groups, who typically need to work long hours while also in school and hence <a href="https://journals.sagepub.com/doi/full/10.1177/2378023116664351">engage</a> less with both the academic and nonacademic aspects of college.</p>
<p>But they also reflect significantly lower post-graduation incomes for such students, due in no small part to continuing social and racial wage gaps in the labor market. Black men with a bachelor’s degree make, on average, more than <a href="https://www.frbsf.org/economic-research/files/el2017-26.pdf?mod=article_inline">20% less than white men</a> with the same education and experience, though that wage gap is smaller for women. And first-generation graduates typically make <a href="https://link.springer.com/article/10.1007/s11162-018-9523-1">10% less than students whose parents graduated</a> from college.</p>
<p>A second moral concern is that student debt is increasingly causing widespread distress and constraining life choices in significant ways. Consider that even before the pandemic, <a href="https://www.federalreserve.gov/publications/2019-economic-well-being-of-us-households-in-2018-student-loans-and-other-education-debt.htm">20% of student borrowers</a> were behind on their payments, and first-generation borrowers and borrowers of color are struggling even more. </p>
<p>The financial distress indicated by this high rate of delinquency is undermining both the <a href="https://ideas.repec.org/a/kap/jfamec/v40y2019i1d10.1007_s10834-018-9594-3.html">physical</a> and <a href="https://www.sciencedirect.com/science/article/abs/pii/S0277953614007503">mental</a> health of young adults. It prevents young adults from starting <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2968250">families</a>, purchasing cars, renting or buying their own <a href="https://www.sciencedirect.com/science/article/abs/pii/S0927537117303317">homes</a> and even starting new <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2633951">businesses</a>. </p>
<p>Unsurprisingly, these negative effects are <a href="https://journals.sagepub.com/stoken/default+domain/10.1177%2F2167696819879252/full">disproportionately</a> experienced by first-generation, low-income and Black student borrowers, whose life choices are especially restricted by the need to make loan payments. </p>
<p>[<em>Deep knowledge, daily.</em> <a href="https://theconversation.com/us/newsletters/the-daily-3?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=deepknowledge">Sign up for The Conversation’s newsletter</a>.]</p>
<h2>Avoiding moral hazard</h2>
<p><a href="https://www.forbes.com/sites/prestoncooper2/2019/10/28/the-massive-moral-hazard-problem-in-mass-student-loan-forgiveness/?sh=73667707e927">Some analysts</a> have argued, however, that canceling student debt will create a problem of moral hazard. A moral hazard arises when people no longer feel the need to make careful choices because they expect others to cover the risk for them.</p>
<p>For example, a bank that expects to be bailed out by the government in the event of a financial crisis thereby has an incentive to engage in riskier behavior. </p>
<p>Moral hazard can be avoided by combining student debt cancellation with programs that reduce the need for future borrowing, especially for first-generation students, low-income students and students of color. </p>
<p>One success story is the Tennessee Promise, a program enacted in 2015 to make tuition and fees at community and technical colleges free to state residents. This program has <a href="https://comptroller.tn.gov/content/dam/cot/orea/advanced-search/2020/TNPromiseMo4Final720.pdf">increased enrollment</a>, retention and completion rates, <a href="https://www.academia.edu/39369076/Do_Promise_Programs_Reduce_Student_Loans_Evidence_from_Tennessee_Promise">while reducing borrowing by over 25%</a>. </p>
<p>Ultimately, morality requires a forward-looking as well as a backward-looking approach to debt cancellation. </p>
<p>Looking backward at initial promises to repay can explain why people are generally required to pay their debts. But looking forward will enable policymakers to imagine how canceling student debt could help create a fairer society.</p><img src="https://counter.theconversation.com/content/150606/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kate Padgett Walsh does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>President-elect Joe Biden promised to forgive some part of student debt. An ethicist considers what’s fair.Kate Padgett Walsh, Associate Professor of Philosophy, Iowa State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1498982020-11-11T20:33:05Z2020-11-11T20:33:05ZNegative interest rates could be coming. What would this mean for borrowers and savers?<figure><img src="https://images.theconversation.com/files/368775/original/file-20201111-15-1i4z726.jpg?ixlib=rb-1.1.0&rect=5%2C0%2C3808%2C2160&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">www.shutterstock.com'</span></span></figcaption></figure><p>There’s a row brewing in the corridors of financial power. The Reserve Bank of New Zealand (RBNZ) recently advised the trading banks that the <a href="https://www.rbnz.govt.nz/monetary-policy/official-cash-rate-decisions">official cash rate</a> might move from the barely positive into the negative. </p>
<p>Right now the RBNZ is holding off such a move in favour of <a href="https://www.rbnz.govt.nz/news/2020/11/more-monetary-stimulus-provided">other monetary stimulus</a> measures. But the big banks <a href="https://www.interest.co.nz/banking/107660/negative-interest-rate-scrap">strongly oppose</a> negative rates, arguing they’ve had limited success overseas and that the country’s banking technology isn’t up to it.</p>
<p>For the central bank, however, it remains an option to stimulate spending, investment and employment as part of the COVID-19 recovery. By reducing the cost of borrowing, economic activity picks up — or so the theory goes.</p>
<p>Those turning to unconventional monetary policy include Japan, Switzerland and the European Union. <a href="https://www.abc.net.au/news/2019-10-22/will-australian-mortgage-rates-become-negative/11623088">Negative rates range</a> from –0.1% to –0.8% for selected tiers of central bank deposits.</p>
<p>In the past, cash rate changes have fed through to changes in loan and deposit rates. For example, a 25-<a href="https://www.investopedia.com/terms/b/basispoint.asp">basis-point</a> drop in the cash rate may result in an annual interest saving of $2,500 on a NZ$1 million loan. </p>
<p>At the current low interest rates, however, these changes are no longer passed on — significantly limiting the powers of the RBNZ.</p>
<h2>Yes, the bank pays you to borrow</h2>
<p>It might sound crazy, but if the lending rate is negative and you borrow an amount on interest-only terms, the bank actually pays you interest every period. For example, Jyske Bank in Denmark is <a href="https://www.theguardian.com/money/2019/aug/13/danish-bank-launches-worlds-first-negative-interest-rate-mortgage">offering negative interest payments</a> by effectively reducing the repayment period. </p>
<p>Banks should be comfortable offering negative rates to borrowers if, in turn, the banks themselves have savings and other funding at even lower rates.</p>
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<a href="https://theconversation.com/with-house-prices-soaring-again-the-government-must-get-ahead-of-the-market-and-become-a-customer-of-first-resort-149446">With house prices soaring again the government must get ahead of the market and become a 'customer of first resort'</a>
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<p>But this is the issue: why would savers pay banks to accept deposits? First, they can hold their investments in cash at a zero-interest rate rather than pay a bank. Second, they can choose to invest in riskier assets with positive interest rates.</p>
<p>Because of this, only very large depositors (with limited ability to store cash) tend to leave their money in banks offering negative rates, while ordinary depositors receive a rate of zero or more.</p>
<h2>But do negative rates work?</h2>
<p>Arguably, the era of monetary policy as a tool for stimulating economic investment and activity has come to an end. Negative rates don’t necessarily translate into productive investment and growth.</p>
<p>Countries that have gone negative have not delivered the expected increases in spending and investment. Furthermore, the difficulty of passing negative rates on to depositors means lending and deposit rates no longer follow the cash rate. </p>
<p>This is also evident in Australia, where a cash rate drop from 0.25% to 0.1% has <a href="https://www.9news.com.au/national/commonwealth-bank-cuts-fixed-rate-loans-but-variable-rates-untouched/e1da0757-4dfa-46f0-8908-0266944b2ea2">not been passed on</a> to mortgage borrowers, except in isolated areas such as fixed-rate loans.</p>
<p>The chart below compares the average variable rate on mortgages with the New Zealand cash rate, with the gap growing over time. Charts for Australia and other developed economies would be comparable.</p>
<p><iframe id="bUYoQ" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/bUYoQ/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>The Reserve Bank of Australia (RBA) has advised borrowers to <a href="https://www.abc.net.au/news/2020-11-04/reserve-bank-interest-rate-cut-banks-fixed-home-loan/12847256">change lenders</a> if they don’t pass on rate cuts. But there is little central banks can do to offset what is a systemic problem.</p>
<h2>What are the risks?</h2>
<p>Negative interest rates are unlikely to be the right response to the current COVID shocks. Rather than leading to higher spending, we tend to see the opposite — <a href="https://www.interest.co.nz/banking/106819/reserve-bank-statistics-show-new-zealanders-increased-amount-their-bank-accounts">more saving</a>.</p>
<p>In the long run, however, depositors will seek greater returns and move their funds to riskier asset classes, including housing markets, which will push up prices and reduce affordability for new buyers.</p>
<p>Most economists agree inflation is not a concern for now. But what about the medium term? If interest rates climb again, highly leveraged mortgages may be difficult to service.</p>
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Read more:
<a href="https://theconversation.com/explainer-why-the-government-cant-simply-cancel-its-pandemic-debt-by-printing-more-money-148514">Explainer: why the government can't simply cancel its pandemic debt by printing more money</a>
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<p>Either way, negative rates are not a long-term solution to current economic challenges. We need to find ways to make the national economy more flexible, requiring fewer rescue interventions. </p>
<p>The fragility of supply chains and the still limited movement of labour, goods and services should be priorities. New technologies may become key — innovations that enable working from home and organising activities online have already saved whole industries. </p>
<p>Also, the banking system itself needs reform. Banks work on an assumption of once-in-a-thousand-year shocks — but we have seen two in the past 13 years! </p>
<p>After the 2008 global financial crisis, safety buffers in the financial systems were put in place. For example, bank capital requirements were set high, to be run down in economic downturns. Would now be the right time to run them down rather than insisting they be maintained?</p>
<p>Beyond reaching for negative rates, the need to rethink economic fundamentals and create systems that are more resilient to global shocks should be the lasting lessons of COVID-19.</p><img src="https://counter.theconversation.com/content/149898/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Harry Scheule does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Yes, the bank would effectively pay you to borrow money. But negative interest rates won’t please savers, nor will they meet the big challenges of economic recovery.Harry Scheule, Professor, Finance, UTS Business School, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1485142020-10-22T00:16:30Z2020-10-22T00:16:30ZExplainer: why the government can’t simply cancel its pandemic debt by printing more money<figure><img src="https://images.theconversation.com/files/364862/original/file-20201021-13-1xahq8c.jpg?ixlib=rb-1.1.0&rect=26%2C8%2C5964%2C3359&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">www.shutterstock.com</span></span></figcaption></figure><p>With the government <a href="https://www.stuff.co.nz/national/health/coronavirus/120725802/coronavirus-government-doubles-borrowing-forecast-as-economy-worsens">borrowing heavily</a> to fund its pandemic response and recovery, it has been <a href="https://www.nzherald.co.nz/business/could-nz-write-off-all-its-debt-what-business-leaders-think/UPBQBYLGPOP3IQGN7G5Z5XFAE4/">suggested</a> it could simply cancel its debt by printing more money. That sounds like an attractive idea, but it is one that would have seriously adverse consequences. </p>
<p>Derived from “<a href="https://www.businessinsider.com.au/modern-monetary-theory-mmt-explained-aoc-2019-3?r=US&IR=T">modern monetary theory</a>” (MMT), the suggestion is that expansionary monetary policy (i.e. money creation by the central bank) be used to finance government spending. </p>
<p>According to proponents of MMT, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due. Therefore, there is no risk of defaulting on its debt.</p>
<p>This is a flawed idea based on economic misconceptions. It has been opposed by economists, liberal and conservative, including Nobel laureate and New York Times columnist <a href="https://www.nytimes.com/2019/02/25/opinion/running-on-mmt-wonkish.html">Paul Krugman</a> and Harvard University’s <a href="https://scholar.harvard.edu/files/mankiw/files/skeptics_guide_to_modern_monetary_theory.pdf">Greg Mankiw</a>. </p>
<p>So, what does happen when the government wants to spend more than it raises in tax revenue? It needs to borrow money (known as deficit financing), and so instructs the Treasury to issue debt. </p>
<p>There are three major types of debt: <a href="https://debtmanagement.treasury.govt.nz/government-securities/treasury-bills">treasury bills, treasury notes and treasury bonds.</a>. Treasury bills have the shortest maturity (less than a year) while treasury bonds have maturities of ten years or more. They all must be paid back in the future. </p>
<p>The debt is typically held by banks, institutional investors and managed funds (such as Kiwisaver accounts). Because the government is not expected to default on the loans, the debt is considered to be secure. So, these bonds can typically be issued at lower interest rates than bonds from other financial entities.</p>
<h2>Where government debt goes</h2>
<p>When the Reserve Bank of New Zealand (RBNZ) engages in “<a href="https://www.anz.co.nz/content/dam/anzconz/documents/economics-and-market-research/2020/ANZ-RBNZ-QE-FAQ-20200507.pdf">quantitative easing</a>” it essentially buys up these government issued bonds. To do this, it prints currency to pay for the bonds and this currency goes into circulation, increasing the money supply.</p>
<p>Quantitative easing floods the system with liquidity — the amount of money readily available for investment and spending. In turn, this should put downward pressure on interest rates because money is cheaper to borrow when there is more of it.</p>
<p>The RBNZ can also lower the official cash rate (<a href="https://www.rbnz.govt.nz/monetary-policy/official-cash-rate-decisions">OCR</a>) to push retail interest rates (on mortgages and savings deposits) down. The aim in both cases is to make borrowing cheaper in the hope that businesses will borrow money to invest, in turn creating more jobs.</p>
<p>If the RBNZ is buying government bonds from the banks and investors who had bought them earlier, it follows that the creditors have been paid off. So why can’t the government simply write off this debt?</p>
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<a href="https://theconversation.com/with-a-mandate-to-govern-new-zealand-alone-labour-must-now-decide-what-it-really-stands-for-144490">With a mandate to govern New Zealand alone, Labour must now decide what it really stands for</a>
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<p>Firstly, this takes away the RBNZ’s ability to act as an independent entity, which in itself is problematic. But even so, the debt does not disappear, it just takes the form of that additional amount of money floating around the economy. </p>
<p>At some point this extra money will end up being deposited in commercial banks and be held as reserves which earn interest from the RBNZ. </p>
<p>The currency in circulation is also legal tender backed by the authority of the government. If no one else wants to accept it, holders of this money should be able to sell it back to the RBNZ for something of value in return (US dollars, say).</p>
<p>One way or another, sooner or later the debt will have to be honoured.</p>
<h2>The risk of inflation</h2>
<p>In the meantime, if lower interest rates do not lead to business expansion and higher production (and there are good reasons to suppose they may not) then the net result is a larger amount of money circulating in the economy with no new production happening. </p>
<p>This will eventually set off inflationary pressures, which make savers worse off and provide a disincentive for saving. But saving by households is fundamental to making funds available for businesses to borrow.</p>
<p>In the absence of increased production this extra money may also make its way to non-productive financial assets such as equity and houses, setting off <a href="https://www.researchgate.net/publication/316804372_Quantitative_easing_and_asset_bubbles">speculative bubbles</a> in those markets. </p>
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Read more:
<a href="https://theconversation.com/covid-19-is-predicted-to-make-child-poverty-worse-should-nzs-next-government-make-temporary-safety-nets-permanent-147177">COVID-19 is predicted to make child poverty worse. Should NZ's next government make temporary safety nets permanent?</a>
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<p>Why might businesses not expand, even with lower interest rates? In deep recessions it is not the lack of credit that holds them back, it is that they cannot sell their goods at prevailing prices. This reduces demand for labour, further reducing demand for goods because more customers are unemployed.</p>
<p>It becomes a vicious cycle of insufficient demand, where the key issue is not credit or liquidity but rather a <a href="https://researchspace.auckland.ac.nz/handle/2292/13330">crisis of confidence</a>. Monetary policy loses its teeth at this point, leaving fiscal policy (via deficit financing or tax cuts) as the only option.</p>
<h2>It’s all about trust</h2>
<p>However, government borrowing is a long-term game. The entire system, whether deficit financing or printing money, is based on trust — that the government will honour its debt.</p>
<p>Simply put, no government could satisfy all its creditors if they wanted their money back at the same time. But as long as the government keeps making the interest payments on the loans, or at least has the capacity to pay back some of those creditors (sometimes by borrowing even more), the economy remains stable. The juggler’s balls stay in the air.</p>
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Read more:
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<p>If for some reason trust in a government goes, watch the balls come crashing down. Any hint of default or not honouring debt obligations will lead to long-term damage to a government’s reputation and its future ability to borrow. No one will want to hold the government’s debt in the form of government bonds.</p>
<p>When that happens, we see <a href="https://www.investopedia.com/terms/c/capitalflight.asp">capital flight</a> — money flows out of the country as people seek a return elsewhere. The value of the currency goes through the floor, with catastrophic effects on the economy, such as occurred during the <a href="https://en.wikipedia.org/wiki/1997_Asian_financial_crisis">Asian financial crisis</a> in 1997. </p>
<p>The economic crisis New Zealand is facing is real and deep. Attempting to cancel debt would only reduce trust in the government and risk making the crisis worse.</p><img src="https://counter.theconversation.com/content/148514/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ananish Chaudhuri has received funding from the Royal Society of New Zealand Marsden Fund. </span></em></p>Massive borrowing to fund NZ’s economic recovery due to COVID-19 cannot be written off without the risk of worsening the crisis it was designed to meet.Ananish Chaudhuri, Professor of Behavioural and Experimental Economics, University of Auckland, Waipapa Taumata RauLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1435532020-07-28T13:05:30Z2020-07-28T13:05:30ZThe IMF’s $4bn loan for South Africa: the pros, cons and potential pitfalls<figure><img src="https://images.theconversation.com/files/349884/original/file-20200728-15-19u89b5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">South Africa's finance minister Tito Mboweni says the IMF loan will limit the country's economic vulnerabilities which have been exacerbated by COVID-19.</span> <span class="attribution"><span class="source">Gallo Images/Brenton Geach</span></span></figcaption></figure><p><em>The International Monetary Fund (IMF) has approved a R70 billion (US$4.3 billion) loan for South Africa to help the country manage the immediate consequences of the fallout from COVID-19. The Conversation Africa’s editor, Caroline Southey, asked Danny Bradlow to shed some light on what South Africans should expect.</em></p>
<h2>What conditions has the IMF attached to the disbursement?</h2>
<p>The IMF has provided the funding through its <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/02/19/55/Rapid-Financing-Instrument">Rapid Financing Instrument</a>. This is designed to support countries facing an urgent need for financing due to a crisis such as the COVID-19 pandemic. The goal is to help the country face the immediate financial consequences of the crisis. As a result the IMF provides the financing quickly and without strict conditions. The country merely needs to show the IMF that it is facing a crisis, that it will use the funds to deal with the crisis, that it will cooperate with the IMF to solve the balance of payments problems caused by the crisis and to describe the economic policies that it proposes to follow. </p>
<p>In some cases, the IMF may require the country to undertake certain policy actions before it can access the funds.</p>
<p>In South Africa’s case, the country’s payments problem relates to the fact that the economy is expected to contract by about 7% this year and the budget deficit to increase to <a href="https://www.gov.za/speeches/minister-tito-mboweni-2020-supplementary-budget-speech-24-jun-2020-0000">about 15% of GDP</a>. This means that the government will need to increase the amount it has to borrow. Given that it has been <a href="https://www.fitchratings.com/research/islamic-finance/fitch-downgrades-south-africa-to-bb-outlook-negative-03-04-2020">downgraded</a> by <a href="https://www.reuters.com/article/safrica-ratings/moodys-downgrades-south-africa-sovereign-rating-to-junk-idUSL8N2BK8M5">credit rating agencies</a>, and that the economy is in bad shape, there is a substantial risk that both local and foreign investors will have a limited appetite for South African debt. This will complicate the government’s efforts to finance the deficit. </p>
<p>The IMF loan helps resolve this problem. </p>
<p>South Africa provided the requisite information to the IMF in the form of a letter of intent signed by the minister of finance and the governor of the Reserve Bank. The letter has not yet been made public. But, according to the <a href="https://www.imf.org/en/News/Articles/2020/07/27/pr20271-south-africa-imf-executive-board-approves-us-billion-emergency-support-covid-19-pandemic">IMF press release</a>, South Africa seems to have informed the IMF that it intends to take certain steps to stabilise the country’s finances. This means that the government will cut government spending to reduce its need to borrow. The current disputes over public sector wages and funding for state owned enterprises are examples of steps it could take. The government has also said it will improve the governance of state owned enterprises, and introduce reforms to stimulate a growing and inclusive economy. These reforms could include measures to improve competition in different sectors of the economy. </p>
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Read more:
<a href="https://theconversation.com/south-africans-should-accept-that-the-imf-is-neither-their-worst-enemy-nor-their-saviour-143199">South Africans should accept that the IMF is neither their worst enemy nor their saviour</a>
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<p>South Africa made these undertakings in last October’s <a href="http://www.treasury.gov.za/documents/mtbps/2019/mtbps/FullMTBPS.pdf">medium term budget statement</a> and in the supplementary budget statement in <a href="https://www.gov.za/speeches/minister-tito-mboweni-2020-supplementary-budget-speech-24-jun-2020-0000">June this year</a>. </p>
<p>This suggests that the IMF is merely expecting the country to implement the policies already announced by the government.</p>
<h2>How will the money be disbursed?</h2>
<p>This kind of financing is provided in one payment. The IMF press statement doesn’t say when the funds will be disbursed but the goal is to make the funds available “rapidly”. That could be as early as August. </p>
<p>Once the funds are disbursed, the government will be free to spend them. According to the national treasury’s <a href="https://www.gov.za/speeches/treasury-imf-approval-us43-billion-financial-support-south-africa-deal-coronavirus-covid-19">statement</a>, it plans to use the money to support health and frontline services, to protect the vulnerable, drive job creation, support economic reform and stabilise public debt. </p>
<p>These are all consistent with the purpose of the Rapid Financing Instrument and the government’s stated intentions. </p>
<p>But these purposes are very general and we will need to see more detail about what exactly the government will spend the funds on.</p>
<h2>What restrictions are there on the government’s ability to use the money?</h2>
<p>The IMF loan <em>does not</em> impose any conditions over and above what is in South African law on how the funds can be used. Consequently, the funds will be subject to the same procurement and accounting requirements as all other budgetary expenditure. </p>
<p>In addition, the government will have to account in its future budget statements and reports to parliament on how the funds have been used. South Africans will also be able to demand that the government demonstrate that the funds have been spent consistently with the requirements of the constitution and bill of rights. This means the government should show that it is using the maximum available resources, from whatever source, to help realise all the rights that the constitution and South Africa’s international commitments grant to South Africans.</p>
<p>The IMF requires that South Africa repay the funds to the IMF over 20 months beginning 40 months after the loan is disbursed. This means that South Africans will need to ensure that the funds to repay the IMF are properly budgeted for.</p>
<h2>What are the upsides of the loan?</h2>
<p>The most important benefit is that South Africa is getting $4.2 billion at about 1.1% interest. This is a very cheap source of funds. If the government tried to raise the same amount either on domestic markets or from other international sources it would pay a considerably higher interest rate – the current rate for government bonds of comparable maturity is about <a href="http://www.worldgovernmentbonds.com/country/south-africa/#:%7E:text=The%20South%20Africa%2010Y%20Government%20Bond%20has%20a%209.155%25%20yield.&text=Normal%20Convexity%20in%20Long-Term,last%20modification%20in%20July%202020">7%</a>.</p>
<p>The second potential benefit is that the IMF loan will catalyse other funds for the country. In other words investors in South Africa and abroad will interpret the IMF’s action as an expression of support for South Africa and this will give them the confidence to invest in South African debt. Given that foreign investors hold about <a href="https://sec.report/Document/0001104659-20-044565/">30% of South African government’s rand denominated debt</a> this boost to confidence could be important. It will both reduce the incentive of these investors to sell their government bonds, potentially pushing up interest rates, and enable the government to issue new debt if needed.</p>
<p>The third benefit is that by helping to stabilise South Africa’s situation, it will limit the damage that may be inflicted on the neighbouring countries. This, in turn, could help South African exports and thus help preserve jobs and income in South Africa.</p>
<h2>What are the downsides?</h2>
<p>The most significant downside is that the loan is denominated in foreign exchange. Thus South Africa has to bear the risk that if the rand depreciates, the loan and the interest on it will become more expensive. Given the state of the South African economy, this is not an insignificant risk. </p>
<p>But it’s important to keep in mind that the IMF denominates the loan and the repayment obligations in Special Drawing Rights. These are the IMF’s special form of money and its value is made up of a composite of a basket of currencies. These include the US dollar, the euro, the Japanese yen, the Chinese renminbi and the pound sterling. The values of these currencies tend to fluctuate against each other so that some appreciate while others depreciate. This helps mitigate the foreign exchange risk that South Africa must bear.</p>
<p>The second risk is that if South Africa does not use the funds from the IMF wisely, the country’s economic situation will deteriorate and it will struggle to pay back the debt. </p>
<p>If this happens or the pandemic lasts longer than anticipated, the country could be forced to seek additional support. In either case South Africa’s negotiating position would be significantly weaker.</p><img src="https://counter.theconversation.com/content/143553/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Danny Bradlow's SARCHI chair is funded by the National Research Foundation. He also has a grant from the Open Society Initiative of Southern Africa (OSISA) for a project on sovereign debt in the SADC region. </span></em></p>The IMF loan does not impose any conditions over and above what is in South African law on how the funds can be used; it only seems to expect the country to implement policies already announced.Danny Bradlow, SARCHI Professor of International Development Law and African Economic Relations, University of PretoriaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1281822019-12-09T13:42:47Z2019-12-09T13:42:47ZPayday lenders have embraced installment loans to evade regulations – but they may be even worse<figure><img src="https://images.theconversation.com/files/305670/original/file-20191206-90603-1dkc76r.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A little cash can be costly.</span> <span class="attribution"><span class="source">AP Photo/Sid Hastings</span></span></figcaption></figure><p>Installment loans seem like a kinder, gentler version of their “predatory” cousin, the payday loan. But for consumers, they may be even more harmful. </p>
<p>Use of the installment loan, in which a consumer borrows a lump sum and pays back the principal and interest in a series of regular payments, <a href="https://www.wsj.com/articles/a-payday-loan-alternative-gains-ground-1470603307?mod=article_inline">has grown dramatically</a> since 2013 as regulators began to rein in payday lending. In fact, payday lenders appear to have developed installment loans <a href="https://www.bloomberg.com/news/articles/2013-05-29/payday-lenders-evading-rules-pivot-to-installmant-loans">primarily to evade</a> this increased scrutiny. </p>
<p>A closer look at the differences between the two types of loans shows why <a href="https://law.vanderbilt.edu/bio/paige-skiba">we believe</a> the growth in installment loans is worrying – and needs the same regulatory attention as payday loans.</p>
<h2>Possible benefits</h2>
<p>At first glance, it seems like installment loans could be less harmful than payday loans. They tend to be larger, can be paid back over longer periods of time and usually have lower annualized interest rates – all potentially good things. </p>
<p>While <a href="https://www.experian.com/blogs/ask-experian/how-payday-loans-work/">payday loans</a> are typically around US$350, installment loans tend to be in the <a href="https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2016/08/from-payday-to-small-installment-loans">$500 to $2,000 range</a>. The potential to borrow more may benefit consumers who have greater short-term needs. </p>
<p>Because installment loans are repaid in biweekly or monthly installments over a period of six to nine months, <a href="https://www.propublica.org/article/installment-loans-world-finance">lenders say</a> consumers are better able to manage the financial strain that brought them to their storefront in the first place. </p>
<p>Payday loans, in contrast, typically require a lump sum payment for interest and principal on the borrower’s very next pay date, often just a few days away. Lenders offer cash in exchange for a post-dated check written from the borrower’s checking account for the amount borrowed and “fees” – what they often dub “interest” to skirt usury rules. </p>
<p>Finally, and perhaps most importantly, installment loans are often cheaper than payday loans, with annualized interest rates of <a href="https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2016/08/from-payday-to-small-installment-loans">around 120%</a> in some states, compared with payday loans’ <a href="https://blog.risecredit.com/know-you-owe-installment-loans-vs-payday-loans/">typical 400% to 500% range</a>.</p>
<h2>Harmful to consumers</h2>
<p>Unfortunately, some of the structural features that seem beneficial may actually be harmful to consumers – and make them even worse than payday loans. </p>
<p>For example, the longer payback period keeps borrowers indebted longer and requires sustained discipline to make repayments, perhaps increasing stress and opportunities for error. </p>
<p>And the fact that the loan amounts are larger may cut both ways. </p>
<p>It is true that the small size of payday loans often isn’t enough to cover a borrower’s immediate needs. <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-finds-four-out-of-five-payday-loans-are-rolled-over-or-renewed/">About 80% of payday borrowers</a> do not repay their loan in full when due but “roll over” their loan into subsequent paycheck. Rolling over a loan allows borrowers to repay merely the interest, then extend the loan in exchange for another pay cycle to repay at the cost of another interest payment.</p>
<p>In a <a href="https://ssrn.com/abstract=3497095">recent study</a>, we explored the effect that the larger installment loan sizes have on borrowers. We used a dataset containing thousands of installment loan records in which some borrowers received a larger loan because they earned a higher income. Although similar in terms of factors such as credit risk and income level, slightly higher-income borrowers were offered a $900 loan, while others got only $600. </p>
<p>We found that borrowers with those larger loans were more likely to have subsequently taken out debt on other installment loans, storefront and online payday loans and auto title loans. Our results suggest that the higher initial installment loan might not serve its main purpose of helping borrowers manage their finances and actually may have caused increased financial strain.</p>
<h2>Misuse and abuse</h2>
<p>As some of <a href="https://doi.org/10.1111/jmcb.12175">our previous research has shown</a>, even payday loans, with their sky-high annualized rates and balloon payments, can be beneficial to consumers in some instances.</p>
<p>Installment loans are no different. When used carefully, they can help low-income consumers with no other credit access smooth consumption. And when they are paid back on time, the loans can certainly provide a net benefit. </p>
<p>But their nature means they are also rife for misuse and abuse. And any negative effects will apply to a broader group of consumers because they are deemed more “mainstream” than payday loans. Lenders are targeting consumers with higher credit scores and higher incomes than <a href="https://www.opploans.com/payday-news/who-uses-payday-loans-the-most/">those of the “fringe” borrowers</a> who tend to use payday loans.</p>
<p>Installment lending accounts for an <a href="https://www.clarityservices.com/wp-content/uploads/2019/04/2019-Alternative-Financial-Services-Lending-Trends.pdf">increasingly large portion</a> of the alternative credit industry. If regulatory crackdowns on payday lending continue, installment lending is likely to become the bulk of lending in the small-dollar, high-interest lending market. </p>
<p>Given the current lack of regulation of these types of loans, we hope they receive increased scrutiny.</p>
<p>[ <em>You’re smart and curious about the world. So are The Conversation’s authors and editors.</em> <a href="https://theconversation.com/us/newsletters/weekly-highlights-61?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=weeklysmart">You can get our highlights each weekend</a>. ]</p><img src="https://counter.theconversation.com/content/128182/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Use of installment loans has grown dramatically in recent years – all without the regulatory scrutiny that tamped down on abuses in the payday loan market.Paige Marta Skiba, Professor of Law, Vanderbilt UniversityCaroline Malone, Ph.D. Student in Law and Economics, Vanderbilt UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1169992019-05-16T20:05:05Z2019-05-16T20:05:05ZYour credit report is a key part of your privacy – here’s how to find and check it<figure><img src="https://images.theconversation.com/files/274769/original/file-20190515-69192-5qp08u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Privacy Act gives you the right to find out what’s in your credit report and change any incorrect information in your report.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/business-woman-hands-working-financial-plan-646040347?src=X3er8kj77M7s2B5Em_fOXA-1-76">from www.shutterstock.com</a></span></figcaption></figure><p>The Australian government encourages citizens to protect their privacy and personal information. </p>
<p>Most of the <a href="https://www.oaic.gov.au/individuals/privacy-fact-sheets/general/privacy-fact-sheet-8-ten-tips-to-protect-your-privacy">tips provided</a> by the Office of the Information Commissioner are pretty intuitive – know your rights, read privacy policies, use security software and more. </p>
<p>But you might be surprised to know “check your credit report” is also on the list of recommended actions. </p>
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Read more:
<a href="https://theconversation.com/seven-ways-the-government-can-make-australians-safer-without-compromising-online-privacy-111091">Seven ways the government can make Australians safer – without compromising online privacy</a>
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<p>Checking your credit report, preferably annually, is a good way to ensure incorrect information is not listed against you. Having the right information in place can protect you against <a href="https://www.moneysmart.gov.au/scams/identity-fraud">identity theft</a>, so is an important component of privacy in this sense. </p>
<p>The <a href="https://www.oaic.gov.au/privacy-law/privacy-act/">Privacy Act 1988</a> is an Australian law which regulates the handling of personal information about individuals. The Privacy Act has very strict rules, reflected in 13 <a href="https://www.oaic.gov.au/privacy-law/privacy-act/australian-privacy-principles">Australian Privacy Principles</a>, that control the way information about you is accessed, used and corrected. </p>
<p>The Privacy Act gives you the right to find out what’s in your credit report and change any incorrect information in your report.</p>
<p>As well as stopping others from stealing your identity, having an accurate credit report is also crucial if you want to borrow money. For example, when applying for credit such as a home loan, the lender will obtain your credit report to assess your credit worthiness and also your ability to repay the loan. You really don’t want your application for a home loan to be knocked back because of errors in your credit report, do you? </p>
<h2>How to check your credit report</h2>
<p>The first step is getting a copy of your credit report. This can be obtained free from credit reporting agencies such as <a href="https://www.equifax.com.au/">Equifax</a>, <a href="https://www.illion.com.au/">illion</a> and <a href="http://www.experian.com.au/">Experian</a>. Tasmanians can also refer to the <a href="https://www.tascol.com.au/">Tasmanian Collection Service</a>. </p>
<p>Make sure you spend a bit of time looking carefully for this free option – it is there, but can sometimes be a little buried. </p>
<p>The report will be sent to you in about ten days. If you are in a hurry and need it faster, you can pay between A$30 to A$50 dollars and the credit report will arrive in a day or two. </p>
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Read more:
<a href="https://theconversation.com/another-day-another-data-breach-what-to-do-when-it-happens-to-you-99150">Another day, another data breach – what to do when it happens to you</a>
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<h2>Look at the details</h2>
<p>Once you have your credit report, there are <a href="https://www.moneysmart.gov.au/media/400943/your-credit-report.pdf">certain things that you must check</a>. </p>
<p>First, as a minimum, check that your personal details such as name, date of birth, employment and driver’s license or other identifying documents are correct. </p>
<p>Second, have a look at your credit history in the report. This will include details of all credit or loans that you applied for, any overdue payments more than 60 days for which default actions have been initiated, and any other credit infringements. Such credit infringements can be listed on your credit report for between five to seven years, depending on their severity. </p>
<p>Third, examine your repayment history to determine whether you missed any payments on due dates. </p>
<p>Last, check whether any recorded serious adverse credit activities such as bankruptcies, court judgements and debt agreements are correct and accurately reflect your circumstances.</p>
<h2>What happens if it’s wrong?</h2>
<p>You are entitled to request changes to any incorrect listing and this should be done free for you. </p>
<p>In the first instance, you can contact the credit reporting agency directly and they will be able to fix small errors immediately. For other errors originating from a credit provider such as a bank, they will sometimes even contact the bank on your behalf. </p>
<p>However, if you have to contact the credit provider yourself, do so and explain why the listing is incorrect. Most often, they will fix the mistake. If they refuse, you can then go to an independent dispute resolution scheme, such as the <a href="https://www.afca.org.au/">Australian Financial Complaints Authority</a>. </p>
<p>If all else fails, you can also contact the <a href="https://www.oaic.gov.au/">Office of the Australian Information Commissioner</a> who will deal with your complaint if it is not older than a year.</p>
<p>So, what are you waiting for? It really is in your best interest to check your credit report, and no one else can do it for you.</p><img src="https://counter.theconversation.com/content/116999/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Checking your credit report is a good way to ensure that incorrect information is not listed against you, and can protect you against identity theft.Harjinder Singh, Senior lecturer, Curtin UniversityNigar Sultana, Senior Lecturer, Faculty of Business and Law, Curtin UniversityYeut Hong Tham, Lecturer, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1061382018-11-08T11:48:02Z2018-11-08T11:48:02ZWhat is public service loan forgiveness? And how do I qualify to get it?<figure><img src="https://images.theconversation.com/files/243350/original/file-20181031-122150-ccipsn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Public Service Loan Forgiveness can be difficult to get if you don't know the rules.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/loan-forgiveness-debt-filling-application-concept-483319924?src=dffCb1tn9FWQSDr2Aiff5A-2-67">Rawpixel.com/www.shutterstock.com</a></span></figcaption></figure><p>The first group of borrowers who tried to get Public Service Loan Forgiveness – a <a href="https://www.congress.gov/bill/110th-congress/house-bill/2669/text">George W. Bush-era program</a> meant to provide relief to those who went into socially valuable but poorly paid public service jobs, such as teachers and social workers – mostly ran into a brick wall.</p>
<p>Of the 28,000 public servants who applied for <a href="https://studentaid.ed.gov/sa/about/data-center/student/loan-forgiveness/pslf-data">Public Service Loan Forgiveness</a> earlier this year, <a href="https://www.nytimes.com/2018/09/27/business/student-loan-forgiveness.html">only 96 were approved</a>. Many were denied in large part due to government contractors being <a href="https://www.npr.org/2018/10/17/653853227/the-student-loan-whistleblower">less than helpful</a> when it came to telling borrowers about Public Service Loan Forgiveness. Some of these borrowers will end up getting part of their loans forgiven, but will have to make more payments than they expected.</p>
<p>With Democrats having regained control of the U.S. House of Representatives in the November 2018 midterm elections, the Department of Education will likely face <a href="https://www.insidehighered.com/news/2018/11/07/democratic-house-will-trigger-tougher-oversight-devos?utm_source=Inside+Higher+Ed&utm_campaign=337cf125c6-DNU_WO20181105_NEW_COPY_01&utm_medium=email&utm_term=0_1fcbc04421-337cf125c6-197753861&mc_cid=337cf125c6&mc_eid=dfc936a128">greater pressure</a> for providing better information to borrowers, as it was <a href="https://www.gao.gov/products/GAO-18-547">told to do</a> recently by the Government Accountability Office.</p>
<p>The Public Service Loan Forgiveness program forgives loans for students who made 10 years of loan payments while they worked in public service jobs. Without this loan forgiveness plan, many of these borrowers would have been paying off their student loans for 20 to 25 years. </p>
<p>Borrowers must follow a <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service">complex set of rules</a> in order to be eligible for the Public Service Loan Forgiveness program. As a professor who <a href="https://scholar.google.com/citations?user=qrYZ8cwAAAAJ&hl=en&oi=ao">studies federal financial aid policies</a>, I explain these rules below so that up to <a href="https://studentaid.ed.gov/sa/about/data-center/student/loan-forgiveness/pslf-data">1 million borrowers</a> who have expressed interest in the program can have a better shot at receiving forgiveness.</p>
<h2>What counts as public service?</h2>
<p>In general, working for a government agency – such as teaching in a public school or a nonprofit organization that is not partisan in nature – <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service#qualifying-employment">counts as public service for the purposes of the program</a>. For some types of jobs, this means that borrowers need to choose their employers carefully. Teaching at a for-profit school, even if the job is similar to teaching at a public school, would not qualify someone for Public Service Loan Forgiveness. Borrowers must also work at least 30 hours per week in order to qualify.</p>
<h2>What types of loans and payment plans qualify?</h2>
<p>Only Federal Direct Loans <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service#eligible-loans">automatically qualify for Public Service Loan Forgiveness</a>. Borrowers with other types of federal loans must consolidate their loans into a Direct Consolidation Loan before any payments count toward Public Service Loan Forgiveness. The failure to consolidate is perhaps the most common reason why borrowers who applied for forgiveness have been rejected, although Congress <a href="https://www.nytimes.com/2018/10/17/your-money/public-service-loan-forgiveness.html">did provide US$350 million</a> to help some borrowers who were in an ineligible loan program qualify for Public Service Loan Forgiveness.</p>
<p>In order to receive Public Service Loan Forgiveness, borrowers must also be enrolled in an income-driven repayment plan, which ties payments to a percentage of a borrower’s income. The default repayment option is not income-driven and consists of 10 years of fixed monthly payments, but these fixed payments are much higher than income-driven payments. The bottom line is it’s not enough to just make 10 years of payments. You have to make those payments through an income-driven repayment plan to get Public Service Loan Forgiveness.</p>
<p>Parent PLUS Loans and Direct Consolidation Loans have <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service/questions">fewer repayment plan options</a> than Direct Loans made to students, so borrowers must enroll in an approved income-driven repayment plan for that type of loan. Borrowers must make 120 months of payments, which do not need to be consecutive, while enrolled in the correct payment plan to receive forgiveness.</p>
<h2>How can borrowers track their progress?</h2>
<p>First of all, keep every piece of information possible regarding your student loan. Pay stubs, correspondence with student loan servicers and contact information for prior employers can all help support a borrower’s case for qualifying for Public Service Loan Forgiveness. Unfortunately, <a href="https://www.npr.org/2018/10/18/658447443/i-am-heartbroken-your-letters-about-public-service-loan-forgiveness">borrowers have had a hard time</a> getting accurate information from loan servicers and the Department of Education about how to qualify for Public Service Loan Forgiveness.</p>
<p>The U.S. Government Accountability Office <a href="https://www.gao.gov/products/GAO-18-547">told the Department of Education</a> earlier this year to improve its communication with servicers and borrowers, so this process should – at least in theory – get better going forward.</p>
<p>Borrowers should also fill out the Department of Education’s <a href="https://studentaid.ed.gov/sa/sites/default/files/public-service-employment-certification-form.pdf">Employment Certification Form</a> each year, as the Department of Education will respond with information on the number of payments made that will qualify toward Public Service Loan Forgiveness. This form should also be filed with the Department of Education each time a borrower starts a new job to make sure that position also qualifies for loan forgiveness.</p>
<h2>Can new borrowers still access Public Service Loan Forgiveness?</h2>
<p>Yes. Although congressional Republicans <a href="https://edworkforce.house.gov/prosper/">proposed eliminating Public Service Loan Forgiveness for new borrowers</a>, the changes have not been approved by Congress. Current borrowers would not be affected under any of the current policy proposals. However, it would be a good idea for borrowers to fill out an Employment Certification Form as soon as possible just in case Congress changes its mind.</p>
<h2>Are there other affordable payment options available?</h2>
<p>Yes. The federal government <a href="https://studentaid.ed.gov/sa/repay-loans/understand/plans/income-driven">offers a number of income-driven repayment options</a> that limit monthly payments to between 10 and 20 percent of “discretionary income.” The federal government determines “discretionary income” as anything you earn that is above 150 percent of the <a href="https://aspe.hhs.gov/poverty-guidelines">poverty line</a>, which would translate to an annual salary of about $18,000 for a single adult. So if you earn $25,000 a year, your monthly payments would be limited to somewhere between $700 and $1400 per year, or about $58 and $116 per month.</p>
<p>These plans are not as generous as Public Service Loan Forgiveness because payments must be made for between 20 and 25 years – instead of 10 years under Public Service Loan Forgiveness. Also, any forgiven balance under income-driven repayment options is subject to income taxes, whereas balances forgiven through Public Service Loan Forgiveness are not taxed.</p><img src="https://counter.theconversation.com/content/106138/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Kelchen does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A higher education professor explains the complex rules behind Public Service Loan Forgiveness, a program meant to provide debt relief to student loan borrowers who went into public service jobs.Robert Kelchen, Assistant Professor of Higher Education, Seton Hall UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1002262018-08-28T21:06:17Z2018-08-28T21:06:17ZHow banks have set a trap for the U.S. Fed by creating money<figure><img src="https://images.theconversation.com/files/231017/original/file-20180808-191025-1ywnhri.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The financial system is awash with money, which is why interest rates have been so low for so long.</span> <span class="attribution"><span class="source">(Shutterstock)</span></span></figcaption></figure><p>The 10-year anniversary of the 2008 financial crisis is upon us. </p>
<p>A decade ago, former U.S. president George W. Bush signed into law the <a href="https://business.cch.com/bankingFinance/focus/News/TARPwhitepaper.pdf">money-printing scheme</a> called the Troubled Asset Relief Program (TARP), aimed at purchasing toxic assets and equity from financial institutions to strengthen the country’s shell-shocked financial sector amid the sub-prime mortgage crisis.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=435&fit=crop&dpr=1 600w, https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=435&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=435&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=547&fit=crop&dpr=1 754w, https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=547&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/232121/original/file-20180815-2915-1pbysp2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=547&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">In this 2014 photo, vines cover the front of a boarded-up home in East Cleveland, Ohio. Ohio was one of the Midwest states hardest hit by the sub-prime mortgage crisis that began in 2007.</span>
<span class="attribution"><span class="source">(AP Photo/Mark Duncan)</span></span>
</figcaption>
</figure>
<p>How do banks, treasury departments and central banks create money anyway? And does it work to buoy economies teetering on the brink of collapse?</p>
<p>In the U.S., banks are required to set aside, <a href="https://www.federalreserve.gov/monetarypolicy/reservereq.htm">depending on the total amount</a>, up to 10 per cent of their deposits to be held at the Federal Reserve. </p>
<p>Here’s how the reserve system works. Let’s say you deposit $10,000 at Bank A. The bank sets aside $1,000 as reserve. It will loan out the remaining $9,000 and charge interest, enabling it to make interest payments to depositors and earn interest income. So Bank A becomes a financial intermediary between savers and borrowers, and money keeps getting created.</p>
<p>How? Because there are many banks in the financial system, and they are required to hold only a fraction (10 per cent) of their deposits. Loans end up deposited in other banks, which increases reserves, deposits — and the money supply.</p>
<h2>Money multiplies</h2>
<p>In the U.S., the Treasury Department can sell <a href="https://www.treasury.gov/about/organizational-structure/ig/Pages/Scams/How-Marketable-Treasury-Securities-Work.aspx">IOU papers</a> <a href="https://www.newyorkfed.org/aboutthefed/fedpoint/fed41.html">via the Fed</a> to the open market in order to finance government deficits instead of raising taxes. <a href="https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-system.htm">The Fed</a> itself, domestic and foreign banks and investors, and foreign governments will buy and pay for them with American dollars. When the government spends these dollars, they get channelled into the commercial banking system as deposits.</p>
<p>Big <a href="http://cbonds.com/emissions/issue/95667">corporations</a> and <a href="http://cbonds.com/emissions/issue/65871">commercial banks</a> can also sell their own bonds. Today, U.S. <a href="https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/rising-corporate-debt-peril-or-promise">non-financial corporate bonds</a> stand at $4.8 trillion. And so the system’s money multiplier gets even larger.</p>
<p>When the Fed buys financial assets from financial institutions, it pays for them by making bookkeeping entries into their reserve accounts. Banks can create up to $10 in new loans for every one dollar increase in the commercial banks’ reserves.</p>
<p>During the financial crisis of 2007-2008, the Fed engineered what’s called quantitative easing, or QE, by buying many billions of bad assets from endangered banks. </p>
<p>The banks’ damaged assets became safe because the Fed had bought them. And it also allowed banks to extend more credits to, supposedly, stimulate the economy.</p>
<p>This financial injection multiplied, and money flooded the system.</p>
<p>Here’s how and why.</p>
<h2>Bank assets versus liabilities</h2>
<p>Mortgage loans are bank assets because banks can call in the loans and the borrower must pay. Deposits, on the other hand, are bank liabilities because customers can withdraw their money at any time, so banks owe that money to them. </p>
<p>If people start defaulting on their mortgage payments and house prices plummet, it can create fears among depositors; they will rush to take their money out of the bank before it collapses and they lose their savings. So in 2008, the Fed stepped in to nip this fear in the bud to prevent a possible system-wide bank run leading to the collapse of banks.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/232119/original/file-20180815-2912-u0650m.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">When house prices fall and people are worried the economy is on the brink of collapse, they tend to withdraw their money from the bank.</span>
<span class="attribution"><span class="source">(Shutterstock)</span></span>
</figcaption>
</figure>
<p>Today, the cumulative balance of <a href="https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm">the Fed’s financial assets</a> over a 10-year period from 2008 to 2018 has risen to $4.3 trillion from $872 billion, an increase of about 400 per cent. Money keeps multiplying.</p>
<p>Why? Recall that each time the Fed buys financial assets from banks, it pays for them by making bookkeeping entries to banks’ reserve accounts, and for every one dollar increase in their reserve accounts, banks can lend out up to $10.</p>
<h2>Where has all the money gone?</h2>
<p>The financial system is therefore awash with money. That’s why interest rates have been so low for so long. Interest rates, essentially, are the price of money. When the Fed makes it easy for banks to create money, banks must lower the price of money in order to move it into the hands of borrowers. Banks, after all, are in the business of making money by selling money.</p>
<p>And this does not even include <a href="https://www.disnat.com/en/learning/trading-basics/the-money-market/eurodollars?ancre=topArticle">Eurodollars</a>. These are U.S. dollar-denominated deposits at foreign banks or at American bank branches abroad, the amounts of which are hard to estimate. And they are not subject to the Fed’s regulations on required reserves. The world is simply flooded with American dollars, with <a href="https://tradingeconomics.com/euro-area/central-bank-balance-sheet">the Euro</a>, <a href="https://tradingeconomics.com/japan/central-bank-balance-sheet">the yen</a>, <a href="https://tradingeconomics.com/china/central-bank-balance-sheet">the yuan</a> and <a href="https://tradingeconomics.com/united-kingdom/central-bank-balance-sheet">pound sterling</a> all operating under similar QE policy.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/232354/original/file-20180816-2915-1nwfihs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Traders work on the floor of the New York Stock Exchange in July 2018.</span>
<span class="attribution"><span class="source">(AP Photo/Richard Drew)</span></span>
</figcaption>
</figure>
<p>Within the U.S. and major developed and developing economies, part of this flood of cheap money has created significant increases in the world’s <a href="https://www.msci.com/market-size">selected</a> <a href="https://content.knightfrank.com/research/1026/documents/en/global-residential-cities-index-q4-2017-5413.pdf">real estate markets</a> and in <a href="https://www.world-exchanges.org/home/index.php/statistics/annual-statistics">stock markets</a>. By 2017, <a href="http://www.businessinsider.com/here-are-the-20-biggest-stock-exchanges-in-the-world-2017-4">16 of the 20</a> largest stock exchanges in the world have a market capitalization ranging from US$1.2 trillion to $19 trillion.</p>
<p>Key lesson: The Fed can create money, but it’s hard to predict where that money will go.</p>
<h2>Why scant inflation?</h2>
<p>Over the period of 2008 to 2018, the U.S. economy has not experienced noticeable inflation, despite the flood of money into the system. The <a href="https://fred.stlouisfed.org/series/GDPDEF">broadest measure of inflation</a> shows it’s increasing at about 1.55 per cent a year. America does not have a problem of too much money chasing too few goods, because there is plenty of money around for imports. That’s where trade deficits came from.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/donald-trumps-misguided-aversion-to-trade-deficits-97891">Donald Trump's misguided aversion to trade deficits</a>
</strong>
</em>
</p>
<hr>
<p>Meantime, while American after-tax <a href="https://fred.stlouisfed.org/series/CPATAX">corporate profits</a> have grown at a compounded rate of 6.44 per cent per year, <a href="https://fred.stlouisfed.org/series/CES0500000003">workers’ average hourly earnings</a> before tax and before inflation is 2.29 per cent per year, which is practically zero in real terms.</p>
<p>The gigantic money-printing scheme, therefore, appears to have benefited banks, corporations and those who can afford to play in real estate markets, in stock markets and in the broader financial world. Broad-based <a href="https://fred.stlouisfed.org/series/DPCERY2Q224SBEA">personal consumption</a>, however, remains unimpressive compared to pre-2008 periods.</p>
<h2>The Fed is trapped</h2>
<p>The Fed has increased its own <a href="https://apps.newyorkfed.org/markets/autorates/fed%20funds">federal funds rate</a> over the past couple of years from zero to 1.91 per cent to spur rate hikes in the financial sector. This is the rate that short-term commercial interest rates are pegged to. And it has also started to <a href="https://www.businessinsider.com/fed-plan-to-unwind-its-balance-sheet-didnt-skip-a-beat-2018-3">sell off</a> some of its assets back to the market. When it sells assets, the multiplier works in reverse, resulting in less money available and higher interest rates.</p>
<p>The rationale for this strategy is that the real economy seems to have picked up some momentum as <a href="https://fred.stlouisfed.org/series/LNU04000024">unemployment rates</a> are down and <a href="https://fred.stlouisfed.org/series/CPIAUCSL">inflation</a> is ticking up. The QE money that has been circulating on and on within the financial and real estate sectors may finally be going somewhere in real sectors. </p>
<p>But facing a total government debt of <a href="https://fred.stlouisfed.org/series/GFDEBTN">$21 trillion</a> and climbing, the Fed is trapped — higher interest rates means bigger interest payments on government debt.</p>
<p>The Congressional Budget Office (CBO) has projected that the government’s net interest costs alone <a href="https://www.pgpf.org/analysis/2016/12/higher-interest-rates-will-raise-interest-costs-on-the-national-debt">will triple</a> over the next 10 years, rising to be the third largest expenditure item after Social Security and Medicare. </p>
<p>U.S. President Donald Trump’s tax cuts may produce some <a href="https://fred.stlouisfed.org/series/A191RL1Q225SBEA">short-term</a> economic growth, but at the expense of even bigger budget deficits, <a href="https://www.bloomberg.com/news/articles/2018-04-09/u-s-budget-deficit-to-balloon-to-1-trillion-by-2020-cbo-says">rising to exceed</a> $1 trillion annually by 2020. That’s two years ahead of CBO’s previous projection.</p>
<h2>Ending easy money is not easy</h2>
<p>While the Fed has pushed interest rates up, rates in the <a href="https://www.ecb.europa.eu/stats/policy_and_exchange_rates/key_ecb_interest_rates/html/index.en.html">Eurozone</a> and in <a href="http://www3.boj.or.jp/market/en/stat/md180712.htm">Japan</a> remain at or below zero, and QE is still ongoing there. More money will flow into the U.S. to earn higher rates. Adding to the ongoing trade wars, this global uncertainty will, paradoxically, result in higher demand for the dollar. The <a href="https://fred.stlouisfed.org/series/TWEXBMTH">higher dollar</a> will make American exports more expensive and reduce the effects of tariffs on imports.</p>
<p>A silver bullet has yet to be found to break through this vicious circle of debt, the dollar and trade deficit. But interest rates will have to rise to their <a href="https://fred.stlouisfed.org/series/PRIME">normal level</a> soon or pension funds will come under enormous stress to hit the eight per cent <a href="https://www.bloomberg.com/news/articles/2017-08-02/5-is-the-new-8-for-reliable-returns-for-pension-funds">required returns</a> in order to meet their obligations. </p>
<p>This is going to be a test case of the Fed’s independence.</p><img src="https://counter.theconversation.com/content/100226/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Hoa Trinh does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It’s been 10 years since the U.S. signed into law a scheme to print money, essentially, and save the financial sector amid the sub-prime mortgage meltdown. Did it work? And who’s truly benefitted?Hoa Trinh, Instructor of Business Management, University of TorontoLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/814932017-08-03T07:47:19Z2017-08-03T07:47:19ZHaving more, owning less: how to fight throwaway culture<figure><img src="https://images.theconversation.com/files/179435/original/file-20170724-11666-9pmrin.png?ixlib=rb-1.1.0&rect=0%2C2%2C842%2C555&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Waffle making with rented waffle maker from the Library of things.</span> <span class="attribution"><span class="source">Sebastian Wood/Library of Things</span></span></figcaption></figure><p>Until the advent of cheap credit and cheaper item costs, for many consumers in the 1960s, 1970s and 1980s <a href="http://www.forum.radios-tv.co.uk/viewtopic.php?f=5&t=12543">rental was the most accessible way</a> of obtaining products such as televisions, video recorders and washing machines that were high cost and frequently required repair. Now we buy cheap and pile high or just chuck out when something stops working – even if we could fix it. </p>
<p>The consumption of household goods in Western society is now at its upper limit, so much so that Steve Howard, Ikea’s head of sustainability, said it <a href="https://www.theguardian.com/business/2016/jan/18/weve-hit-peak-home-furnishings-says-ikea-boss-consumerism">had reached “peak stuff”</a>. While he was quick to say that this did not contradict Ikea’s target to double sales by 2020, he suggested a break from a prevailing “take, make, use, throw” economic model towards <a href="http://www.wrap.org.uk/about-us/about/wrap-and-circular-economy">a circular model</a> that encourages repair, reuse and collaborative ventures that share the use of products.</p>
<p>At the heart of the circular economy <a href="https://www.pwc.co.uk/issues/megatrends/collisions/sharingeconomy/outlook-for-the-sharing-economy-in-the-uk-2016.html">is the sharing economy</a>, in which products and services are leased for a time. It’s about access rather than ownership, and any number of things can be shared, from <a href="https://www.zipcar.co.uk/what-is-zipcar">transport</a>, <a href="https://www.airbnb.co.uk/?af=43720035&c=A_TC%3Djfaz4zk39c%26G_MT%3De%26G_CR%3D192767240144%26G_N%3Dg%26G_K%3Dairbnb%26G_P%3D%26G_D%3Dc%26%24pi:0.pk:12837552276_192767240144_c_12026464216&atlastest5=true&gclid=CjwKEAjws-LKBRDCk9v6_cnBgjISJAADkzXec5CcO9-GuGUG90df7CbULM0DpfDDe3NnbQUdoTZr2RoCWlXw_wcB">property</a> and consumer goods (such as tools and kitchen appliances), as well <a href="http://www.timebanking.org/what-is-timebanking/about-coproduction/">as skills and knowledge</a>. </p>
<figure class="align-left ">
<img alt="" src="https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/180787/original/file-20170802-8795-174zfnt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Care: paying it forward.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/social-worker-disabled-man-on-walk-485204707?src=8vsu4vr1EiYkfZcu5SSxNg-4-55">Shutterstock</a></span>
</figcaption>
</figure>
<p>Participation in the sharing economy <a href="https://www.theguardian.com/small-business-network/2015/nov/25/cashing-in-spare-room-sharing-entrepreneurs-incomes">lets you use under-utilised assets</a> and <a href="https://www.economist.com/news/britain/21711844-young-people-who-volunteer-now-could-bank-hours-credit-be-redeemed-kind-their-own">even spare time</a> to earn additional income.</p>
<h2>To the future …</h2>
<p>There have been routes to borrowing items for many years – hiring formal clothing for events, for example, or <a href="http://www.sustrans.org.uk/what-you-can-do/use-your-car-less/car-clubs-and-car-sharing">car sharing schemes</a> that are now commonplace in many cities. And despite more recent funding cuts, public libraries still offer access to books, music and films, while big businesses such as Amazon Kindle, Netflix and Spotify mean there is no need to actually own physical, hard copies of media items.</p>
<p>But sharing, borrowing and reusing is now becoming something that businesses are actively engaging in. Take the Riversimple Rasa – a hydrogen fuel cell car that has been <a href="https://theconversation.com/wales-offers-two-bright-alternate-futures-for-the-car-industry-55364">designed specifically within a car-share business model</a>. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/112892/original/image-20160225-15150-w9fkgs.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Rasa.</span>
<span class="attribution"><a class="source" href="http://riversimple.com/">Riversimple</a></span>
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</figure>
<p>After an initial failure, SpaceX’s attempts to recover and reuse its Falcon 9 booster <a href="https://theconversation.com/in-space-this-is-the-age-of-reusability-77964">met with success</a>, and in 2017 one recovered booster was used to launch a communications satellite. Rival company Blue Origin is also developing its reuseables. It means that in the age of space travel, we may already be taking advantage of cheaper, recycled technology.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/180785/original/file-20170802-18749-1951vkh.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Falcon 9 launch in March 2017.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/spacex/32915197674/in/dateposted/">SpaceX/flickr</a></span>
</figcaption>
</figure>
<h2>Libraries of things</h2>
<p>Back down to Earth, local community schemes have the potential to share expensive and rarely used items and change the way household goods are consumed. Grassroots examples include the <a href="http://www.libraryofthings.co.uk/">Library of Things</a> in London, a community business providing low-cost access to items such as DIY tools, sewing machines, camping and gardening equipment, carpet cleaners, projectors and musical instruments. </p>
<p>While sustainability is at the heart of the project, which resists an own everything, <a href="https://en.wikipedia.org/wiki/Throw-away_society">throwaway culture</a>, the library is also a social space with a practical purpose. It reinvents the traditional models of renting, swapping, bartering and gifting, and also offers a place to meet and learn new skills through classes, workshops or one-to-one instruction in cooking, sewing, furniture making and general DIY skills. </p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/wuUAg04KZYI?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
</figure>
<p>This kind of scheme empowers people to use the items they borrow and to do things for themselves. And given that the average electric drill is in use for just 15 minutes each year, and is kept in storage for the rest of the time, it’s clear that many “household” items don’t really need to be owned at all. And sharing or borrowing means <a href="http://www.wrap.org.uk/sites/files/wrap/Drill%20Case%20Study%20AG.pdf">a better environmental impact</a>. </p>
<h2>More for less</h2>
<p>The right to ownership and property is deeply rooted in Western culture for reasons from social status to convenience. Nevertheless, increasing the number of items that are leased or rented is feasible – the sharing economy offers financial savings and access to better quality goods in the short term, while reducing people’s <a href="http://footprint.wwf.org.uk/">personal carbon footprints</a>, and in the case of projects like Library of Things <a href="https://theconversation.com/community-repair-a-pop-up-alternative-to-the-throwaway-society-75821">and repair venture, Restart</a>, a greater sense of community and skills sharing.</p>
<p>Established businesses may see these enterprises as a threat to their business models. After all, if consumers share or rent things, this might impact on sales. However, it could instead incentivise manufacturers to produce more reliable, durable products which they would <a href="https://theconversation.com/riversimples-hydrogen-fuel-cell-rasa-gives-car-design-a-clean-slate-54993">retain ownership of and lease to consumers</a>, remaining responsible for maintenance and replacement costs. This would mean further incentives to design and produce longer-lasting, reliable products which could easily be repaired or re-manufactured and passed onto less demanding customers at a lower cost. </p>
<p>Sharing as part of a circular economy promotes better efficiency in materials, which reduces the lifetime carbon emissions of products that are designed and maintained for optimum life spans and used more intensively. It allows for a growth in consumption without the corresponding demand for resources. This is one area that needs addressing if we are to stand a chance of reaching the targets set in the <a href="http://www.legislation.gov.uk/ukpga/2008/27/contents">Climate Change Act</a> and meeting commitments under the <a href="http://unfccc.int/paris_agreement/items/9485.php">Paris Agreement</a>.</p><img src="https://counter.theconversation.com/content/81493/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christine Cole receives funding from the Engineering and Physical Sciences Research Council as part of her work for the Centre for Industrial Energy, Materials and Products at Nottingham Trent University (grant reference EP/N022645/1).</span></em></p><p class="fine-print"><em><span>Alex Gnanapragasam receives funding from the Engineering and Physical Sciences Research Council as part of his work for the Centre for Industrial Energy, Materials and Products at Nottingham Trent University (grant reference EP/N022645/1).</span></em></p>Why keep buying and chucking when you can rent and return?Christine Cole, Research Fellow, Architecture, Design and the Built Environment, Nottingham Trent UniversityAlex Gnanapragasam, Research Fellow in Sustainable Consumer Behaviour, Nottingham Trent UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/794792017-06-15T10:52:51Z2017-06-15T10:52:51ZAs Fed ‘returns to normal,’ is the risk of recession rising? Experts react<figure><img src="https://images.theconversation.com/files/173911/original/file-20170615-26091-1bokz3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Fed Chair Janet Yellen speaks at a press conference following the rate-hike decision.</span> <span class="attribution"><span class="source">AP Photo/Susan Walsh</span></span></figcaption></figure><p><em>Editor’s note: The Federal Reserve’s policy-setting committee <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm">raised its benchmark interest rate</a> by a quarter-point to a range of 1 to 1.25 percent, the second increase this year. The central bank also indicated that it will likely lift rates once more this year. Given that these developments weren’t exactly a shock, we asked a couple of Fed experts what was noteworthy about the announcement.</em></p>
<h2>What’s the real risk</h2>
<p><strong>Sheila Tschinkel, Emory University</strong></p>
<p>The Fed’s <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm">decision</a> to raise the <a href="https://fred.stlouisfed.org/series/FEDFUNDS">federal funds rate</a> was no surprise to financial markets. Nor was its expectation of one more hike this year. </p>
<p>Even though core inflation <a href="https://www.bls.gov/cpi/">has been below its 2 percent target</a>, the economy’s underlying strength suggests little or no risk of recession or deflation. </p>
<p>The Fed also said it is <a href="http://www.businessinsider.com/federal-reserve-rate-hike-plan-to-unwind-45-trillion-balance-sheet-2017-6">ready to begin reducing its holdings</a> of government and other securities later this year. As a result of “quantitative easing” – the purchase of mortgage-backed and government securities to reduce long-term borrowing costs – and other measures aimed at preventing a collapse of the financial system, the value of assets on its balance sheet <a href="https://www.federalreserve.gov/monetarypolicy/files/quarterly_balance_sheet_developments_report_201705.pdf">ballooned to US$4.47 trillion</a> from <a href="https://www.federalreserve.gov/boarddocs/rptcongress/annual07/sec6/c3.htm">$915 billion</a> at the end of 2007. </p>
<p>The Fed seems to believe the bigger risk, actually, is that the economy could overheat, particularly if ultra-low rates are combined with <a href="http://www.marketwatch.com/story/trumps-infrastructure-plan-could-be-a-powerful-economic-stimulus-2017-06-05">government stimulus</a> (which is still up in the air). The upshot is that the Fed seems pretty confident in the economic recovery and thinks it’s time to “begin the return to normal.” </p>
<p>Still, economic growth remains lower than many – including me – would like. It’s <a href="https://tradingeconomics.com/united-states/gdp-growth">ranged</a> from a disappointing 1 percent to 2 percent for the past few years. </p>
<p>The bigger risk facing the Fed might be that the economy is fundamentally not as strong the central bank believes it is. In that case, if the Fed continues to “normalize,” the economy could weaken and even go into recession.</p>
<p>Markets seem to reflect this view. <a href="http://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart">Yields on 10-year U.S. Treasuries</a>, for example, are actually lower than they were in November, even though the Fed has lifted its target interest rate by a quarter-point three times since then. This suggests investors are still anxious about the state of the U.S. and global economies – or something entirely different could be at work.</p>
<p>Without a crystal ball, we don’t know which view is right. While I can’t explain why bond yields have declined, I do believe the U.S. economy is doing all right and the Fed is on a reasonable path to normal.</p>
<h2>The Fed’s balance sheet quandary</h2>
<p><strong>William D. Lastrapes, University of Georgia</strong></p>
<p>Today’s announcement provides the first glimpse into how the Fed hopes to downsize a historically huge balance sheet. In other words, how does it plan to <a href="https://www.federalreserve.gov/monetarypolicy/files/quarterly_balance_sheet_developments_report_201705.pdf">reduce the $4.2 trillion in government bonds</a>, mortgage-backed securities and other assets it holds? </p>
<p>The Fed plans to take a <a href="http://www.businessinsider.com/federal-reserve-rate-hike-plan-to-unwind-45-trillion-balance-sheet-2017-6">gradual approach</a>. Essentially, the securities on the Fed’s balance sheet are continually maturing. As they do, the Fed has been taking the principal it collects and reinvesting it back in new securities. When the bank is ready to begin paring its holdings, it can simply stop reinvesting those proceeds, which will allow its balance to gradually decline. Or, if it would like to speed things up, it could sell some securities on the open market before they mature. </p>
<p>In other words, imagine your teenage self has seven $100 bills and you lend each to a friend in need on a different day of the week, starting on Monday, for a term of seven days. Come the following Monday, when the first bill is repaid, you decide to lend it out to someone else and continue to do so indefinitely. Essentially your balance sheet would always show $700 in assets. Then, if you decided to unwind your little bank, instead of relending the bills you began keeping them as they came due, thereby gradually reducing your assets until they hit zero. </p>
<p>There’s a flip side, however, as for every asset there needs to be a liability. And for every dollar drop in assets on the Fed’s balance sheet there needs to be a corollary decline in its liabilities. For your mini-bank, that liability might be the $700 you borrowed from your parents. And so when you stop relending those bills, you paid them back to your mom and dad, reducing what you owe. </p>
<p>The Fed borrows its money from banks in the form of “reserves” and so reduces these reserves when lending slows. And that’s where it finds itself in a serious quandary that could derail the economic recovery if not handled well. </p>
<p>Bank reserves – the safe and liquid cash assets that financial institutions hold as deposits at the Fed – <a href="https://www.federalreserve.gov/releases/h41/current/">currently total $2.2 trillion</a>, up from <a href="https://www.federalreserve.gov/releases/h41/20071227/">$5.8 billion in the last week of December 2007</a>. Almost all of these reserve holdings are excess reserves, which means they’re more than the Fed requires banks to hold in order to back up their deposits. </p>
<p>Why would banks keep so much of their portfolios in simple cash assets at the Fed and not in other securities or loans to businesses? One reason is that banks still desire safe and easily redeemable assets because of <a href="https://www.washingtonpost.com/news/wonk/wp/2017/04/21/trump-orders-another-review-of-post-financial-crisis-regulations-on-wall-street/">post-financial crisis regulations</a> and other lingering effects of the crisis. And what’s safer than the Fed, right? </p>
<p>An even bigger factor is that the Fed pays a relatively high yield on those excess reserves, now 1.25 percent, which exceeds what banks could get in comparably safe, short-term investments elsewhere. Why invest in anything else when parking that cash at the Fed is profitable and there is absolutely no default risk? </p>
<p>The problem for Chair Janet Yellen and her colleagues at the Fed is that if they try to pare back its balance sheet, banks may respond by cutting back on their own assets, such as loans to businesses and consumers, which in turn causes checking deposits and the money supply to drastically contract. The consequences are serious and include deflation and even recession. </p>
<p>So why not just reduce the rate it’s paying to the banks so that they don’t want to leave so much of their money at the Fed and instead lend it out? Increasingly, the Fed has been using interest rates on reserves as a way to help it set monetary policy and control its all-important federal funds rate. So if it lowers the interest rate on reserves, that’ll make hitting market interest rate targets that much more difficult.</p>
<p>The Fed now seems to get this and noted in its announcement that it plans to move cautiously on normalization while paying attention to the behavior of banks. The buildup of the Fed’s balance sheet during the financial was unprecedented. And now, so is policy normalization. Fed policymakers are correct to be cautious in their approach.</p><img src="https://counter.theconversation.com/content/79479/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Federal Reserve lifted rates for the second time this year and expects to do so once more, suggesting it’s fairly confident the economic recovery will continue. Is it overconfident?Sheila Tschinkel, Visiting Faculty in Economics, Emory UniversityWilliam D. Lastrapes, Professor of Economics, University of GeorgiaLicensed as Creative Commons – attribution, no derivatives.