Credit crunch, fuel prices, and all that

With gas and electricity prices soaring, most of us get a first-hand experience of the effects of the so-called ‘credit crunch’ and rising oil prices. With utility bills eye-wateringly high and food prices rising too, a lot of people demand immediate action from the government. In fact, just today angry lorry drivers have been blocking motorways in London and Wales. Whereas the government points to difficult international economic conditions, the notorious oil market in particular, the opposition, of course, holds the government responsible for what some commentators already call the current economic crisis. With emotions running high, and self-acclaimed experts constantly trumpeting their opinions on every TV channel, I want to know what a ‘credit crunch’ really is. And what does it have to do with anything? All this talk worries me – will the government, hoping to appease voters, clamp down on environmental policies and fuel taxes? Could we have avoided this mess had we invested more in renewable energy sources? Some people even call for a renaissance of nuclear power. All of this seems quite interrelated, so what’s the connection?

I run a quick search on IBSS, combining the keywords ‘Credit market’, ‘Credit crunch’, and ‘United Kingdom’. This gives me a nice and manageable 25 hits, the first one of which is a recent survey carried out by the Bank of England: ‘Household Debt and Spending: Results from the 2007 NMG Research Survey’ (M Waldron and G Young, Bank of England quarterly bulletin. 47(4) 2007 Winter, 512-521), pointing out that already at the end of last year renters were facing increasingly severe financial pressures. I find a number of papers that test empirically the relationship between what the government, the Bank of England, banks and consumers are doing. One example is ‘The Credit Channel of Monetary Policy: Evidence from the Housing Market’ (M Lacoviello and R Minetti, Journal of macroeconomics. 30(1) 2008, 69-96). The authors specify the reaction of the housing and mortgage markets to changes in central banks’ interest rate policies. I get an idea of how these abstract market issues relate to the real world: the Bank of England sets key interest rates; this is what banks have to pay when they borrow money from the central bank. Due to inflationary pressures – in particular high oil prices! – the Bank of England has kept the rates quite high in order to avoid banks giving away too much ‘cheap money’ to their customers, who then would run off to spend it all, only to increase inflation even further! But high interest rates mean high mortgage costs, and then there’s the role of expectations: if everyone, buyers and banks, expect housing prices to fall they will go down eventually as buyers sit back and wait, and banks grow more reluctant to grant buyers a loan – the credit market contracts, this is the evil credit crunch. Running a quick search on ‘Housing market’ and ‘Expectations’ brings up a couple of interesting papers that explain this link in detail. So it seems the credit market has quite some influence on what’s going on in the economy as a whole. And the Bank of England can’t just lower the rate to make buyers happy, as inflation is quite high already, and surely no one would want prices to go up even further.

The rise in oil prices affects everyone, whether you’re driving a car or not. Just search for ‘Oil prices’ and ‘United Kingdom’ to get a dozen or so good articles that work out what these effects are: higher transport costs mean higher retail prices, as goods need to get shipped to local supermarkets. Which leads straight on to an issue well-discussed these days: transport and environmental policies. S Gleister: ‘UK Transport Policy 1997-2001’ (Oxford review of economic policy. 18(2) 2002 Summer, 154-186), is not very happy with the way things have been done since the 1990s; too little freight on rails, and too much control of the Treasury when it comes to local transport infrastructure investment decisions. So I finally run a search combining the keywords ‘Environmental policy’, ‘Transport policy’ and ‘United Kingdom’. I get a thousand or so records, so narrow it down to recent years. Still I get a huge variety of papers, proponents of nuclear energy and wind energy alike, or papers on OPEC policy – it seems the debate has only just begun.