Effects of Credit Crunch

It can be said that ‘credit crunch’ has one of the most concerned issue to discuss since it broke out in September 2008 because of its seriousness and impacts on recent business world. The financial crisis started from the failure and bankruptcy of financial institutions in US due to sub-prime mortgage crisis. As domino effect, the crisis spread globally and has caused catastrophes to many economies up until these days.

As a huge number of companies went bankrupt, unemployment has become one of the most serious long-term consequences of 2008’s crisis. This problem, in addition, cannot be solved in short time. That is why after the crisis, the unemployment rates in some countries have not stopped increasing until now. Prominently, according to the Wall Street Journal on 17 March 2011, Spain hits the first place in unemployment rate chart of euro-zone at 20.4% which doubled the euro-zone average.

Unemployment rate of Spain 1988 - Jan 2011 (Source: Eurostat)

One of the reasons, identified on guardian.co.uk, is that Spain has depended too much on housing market, especially bricks, to grow the economy rather than developing different models. When the financial crisis occurred, the drawbacks were clearer and started to leverage.

Another consequence of financial crisis is the monetary problems and threats of rising inflation rate. These two issues were also discussed in previous blog posts. We all recognized that when remarkable financial crunches occur, the production costs will increase because of the growth in demand. In Cost Push theory, by this, inflation rate starts to rise. It does not necessarily mean that credit crunch cause inflation, but its consequences may. Due to recent escalation in costs of oil, gas and electricity, euro-zone is facing the highest level of inflation ever of 2.4% in February since October 2008. In order to lower the inflation rate, it is necessary to reduce the demand of spending. One of the most effective policies which may have immediate influence is setting higher interest rate. This is what Bank of England did to control the inflation when the credit crunch occurred. The policy has also been deeply recognized by European Central Bank (ECB). The interest rate is said to be increased in April (by Jean-Claude Trichet, a President of ECB) from its very low 1% rate which was last from 2009. This can be seen as direct solution for this dilemma, but it might not work proficiently in long-term or when supply still cannot cover demand even in possible increased rate.